-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, N68hv/2wVZGe2rXLnGQYtkPjrmVkqdyK0g/F3IzAFZ+ZyN0DmXrx/9+/untKFwpj b2In9OkJJ7acbVq27iA1bA== 0001025537-00-000054.txt : 20000417 0001025537-00-000054.hdr.sgml : 20000417 ACCESSION NUMBER: 0001025537-00-000054 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000414 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HOPFED BANCORP INC CENTRAL INDEX KEY: 0001041550 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 561995728 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-23667 FILM NUMBER: 601576 BUSINESS ADDRESS: STREET 1: 2700 FORT CAMPBELL BLVD CITY: HOPKINSVILLE STATE: KY ZIP: 42440 BUSINESS PHONE: 5028851171 MAIL ADDRESS: STREET 1: 2700 FORT CAMPBELL BLVD CITY: HOPKINSVILLE STATE: KY ZIP: 42440 10-K 1 FORM 10-K FOR HOPFED BANCORP, INC. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (Mark One) |X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1999 OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____________________ to ________________ Commission file number 000-23667 ---------------------------- HOPFED BANCORP, INC. -------------------- (Exact name of registrant as specified in its charter) Delaware 61-1322555 - ------------------------------- --------------------- (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 2700 Fort Campbell Boulevard, Hopkinsville, KY 42240 - ----------------------------------------------- ----------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (270) 885-1171. Securities registered pursuant to Section 12(b) of the Act: None. Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $.01 per share -------------------------------------- (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO____ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The registrant's voting stock is traded on the Nasdaq Stock Market. The aggregate market value of the voting stock held by non-affiliates of the registrant, computed by reference to the price ($11.25 per share) at which the stock was sold on March 31, 2000, was approximately $41,614,819. For purposes of this calculation, the term "affiliate" refers to all executive officers and directors of the registrant and all stockholders beneficially owning more than 10% of the registrant's Common Stock. As of the close of business on March 31, 2000, 3,993,592 shares of the registrant's Common Stock were outstanding. Documents Incorporated By Reference Part II: Annual Report to Stockholders for the year ended December 31, 1999. Part III: Portions of the definitive proxy statement for the 2000 Annual Meeting of Stockholders. PART I ITEM 1. BUSINESS In February 1998, HopFed Bancorp, Inc. ( the "Company") issued and sold 4,033,625 shares of common stock, par value $.01 per share (the "Common Stock"), in connection with the conversion of Hopkinsville Federal Savings Bank (the "Bank") from a federal mutual savings bank to a federal stock savings bank and the issuance of the Bank's capital stock to HopFed Bancorp, Inc. (the "Company"). The conversion of the Bank, the acquisition of all of the outstanding capital stock of the Bank by the Company and the issuance and sale of the Common Stock are collectively referred to herein as the "Conversion." HOPFED BANCORP, INC. HopFed Bancorp, Inc. was incorporated under the laws of the State of Delaware in May 1997 at the direction of the Board of Directors of the Bank for the purpose of serving as a savings and loan holding company of the Bank upon the acquisition of all of the capital stock issued by the Bank in the Conversion. The Company's assets primarily consist of the outstanding capital stock of the Bank and a portion of the net proceeds of the Conversion. The Company's principal business is overseeing the business of the Bank and investing the portion of the net Conversion proceeds retained by it. The Company has registered with the Office of Thrift Supervision ("OTS") as a savings and loan holding company. See "Regulation - Regulation of the Company." As a holding company, the Company has greater flexibility than the Bank to diversify its business activities through existing or newly formed subsidiaries or through acquisition or merger with other financial institutions, although the Company currently does not have any plans, agreements, arrangements or understandings with respect to any such acquisitions or mergers. The Company is classified as a unitary savings and loan holding company and is subject to regulation by the OTS. The Company's executive offices are located at 2700 Fort Campbell Boulevard, Hopkinsville, Kentucky 42240, and its main telephone number is (270) 885-1171. HOPKINSVILLE FEDERAL SAVINGS BANK The Bank is a federally chartered stock savings bank headquartered in Hopkinsville, Kentucky, with branch offices in Hopkinsville, Murray, Cadiz and Elkton, Kentucky. The Bank was incorporated by the Commonwealth of Kentucky in 1879 under the name Hopkinsville Building and Loan Association. In 1940, the Bank converted to a federal mutual savings association and received federal insurance of its deposit accounts. In 1983, the Bank became a federal mutual savings bank and adopted its current corporate title. The business of the Bank primarily consists of attracting deposits from the general public and investing such deposits in loans secured by single family residential real estate and investment securities, including U.S. Government and agency securities and mortgage-backed securities. The Bank also originates single-family residential/construction loans and multi-family and commercial real estate loans, as well as loans secured by deposits and other consumer loans. The Bank emphasizes the origination of residential real estate loans with adjustable interest rates and other assets which are responsive to changes in interest rates and allow the Bank to more closely match the interest rate maturation of its assets and liabilities. The primary market area of the Bank consists of the adjacent counties of Calloway, Christian, Todd and Trigg located in southwestern Kentucky. LENDING ACTIVITIES General. The total gross loan portfolio totaled $115.7 million at December 31, 1999, representing 55.7% of total assets at that date. Substantially all loans are originated in the Bank's market area. At December 31, 1999, $88.2 million, or 76.3% of the loan portfolio, consisted of one-to-four family, residential mortgage loans. Other loans secured by real estate include non-residential real estate loans, which amounted to $12.4 million, or 10.7% of the loan portfolio at December 31, 1999, and multi-family residential loans, which were $2.2 million, or 1.9% of the loan portfolio at December 31, 1999. At December 31, 1999, construction loans were $5.7 million, or 4.9% of the loan portfolio, and consumer loans totaled $7.2 million, or 6.2% of the loan portfolio. Analysis of Loan Portfolio. Set forth below is selected data relating to the composition of the loan portfolio by type of loan at the dates indicated. At December 31, 1999, there were no concentrations of loans exceeding 10% of total loans other than as disclosed below.
At December 31, --------------------------------------------------------------------------------------------------- 1999 1998 1997 1996 1995 ----------------- ----------------- ----------------- ----------------- ----------- Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent ------ ------- ------ ------- ------ ------- ------ ------- ------ ------- (Dollars in thousands) Type of Loan: - ------------ Real estate loans: One-to-four family residential........ $ 88,248 76.3% $ 88,954 80.6% $ 83,229 78.7% $77,318 79.6% $70,417 81.5% Multi-family residential........ 2,165 1.9% 1,539 1.4% 2,359 2.2% 1,466 1.5% 492 0.6% Construction......... 5,706 4.9% 4,626 4.2% 5,166 4.9% 5,389 5.6% 4,062 4.7% Non-residential (1).. 12,398 10.7% 8,260 7.5% 7,593 7.2% 5,467 5.6% 5,107 5.9% --------- ------ -------- ------ -------- ------ ------- ------ ------- ------ Total real estate loans........... 108,517 93.8% 103,379 93.7% 98,347 93.0% 89,640 92.3% 80,078 92.7% ========= ====== ======== ======= ======== ====== ======= ======= ====== ======= Consumer loans: Secured by deposits.. 2,525 2.2% 2,280 2.1% 3,081 2.9% 3,484 3.6% 3,324 3.8% Other consumer loans. 4,670 4.0% 4,586 4.2% 4,298 4.1% 4,004 4.1% 3,016 3.5% --------- ------ -------- ------ -------- ------ ------- ------ ------- ------ Total consumer loans 7,195 6.2% 6,866 6.3% 7,379 7.0% 7,488 7.7% 6,340 7.3% --------- ------ -------- ------ -------- ------ ------- ------ ------- ------ 115,712 100.0% 110,245 100.0% 105,726 100.0% 97,128 100.0% 86,418 100.0% ====== ====== ====== ====== ====== Less:.Loans in process. 1,902 1,180 2,019 1,415 1,541 Allowance for loan losses........... 278 258 237 217(2) 122 --------- -------- -------- ------- ------- Total................ $ 113,532 $108,807 $103,470 $95,496 $84,755 ========= ======== ======== ======= =======
- --------------------------- (1) Consists of loans secured by first liens on residential lots and loans secured by first mortgages on commercial real property. (2) Increase in allowance for loan loss reflects $100,000 provision in 1996 based upon management's assessment of risks associated with increased loan growth and increased emphasis on consumer lending. See "--Nonperforming Loans and Other Assets." Loan Maturity Schedule. The following table sets forth certain information at December 31, 1999 regarding the dollar amount of loans maturing in the portfolio based on their contractual maturity, dates. Demand loans, loans having no stated schedule of repayments and no stated maturity, and overdrafts are reported as due in one year or less.
Due after Due after 5 Due after 3 through 5 through 10 10 through Due after Due during the year ending years after years after 15 years 15 years December 31, December 31, December 31, after after ------------------------------- ------------ ------------ December 31, December 31, ------------ ------------ 2000 2001 2002 1999 1999 1999 1999 Total ---- ---- ---- ---- ---- ---- ---- ----- (In thousands) One-to-four family residential............... $2,705 $1,215 $1,201 $2,124 $ 9,665 $22,495 $48,398 $ 87,803 Multi-family residential.. -- -- -- -- -- 790 1,375 2,165 Construction.............. 4,077 -- -- -- -- -- -- 4,077 Non-residential........... 614 55 -- 649 888 4,250 5,836 12,292 Consumer.................. 2,399 526 1,214 2,615 441 -- -- 7,195 ------ ------ ------ ------ -------- ------- ------- --------- Total.................. $9,795 $1,796 $2,415 $5,388 $ 10,994 $27,535 $55,609 $ 113,532 ====== ====== ====== ====== ======== ======= ======= =========
2 The following table sets forth at December 31, 1999, the dollar amount of all loans due one year or more after December 31, 1999 which had predetermined interest rates and have floating or adjustable interest rates. Predetermined Floating or Rate Adjustable Rate ----------------- ---------------- (In thousands) One-to-four family residential..... $15,579 $69,519 Multi-family residential........... -- 2,165 Construction....................... -- -- Non-residential.................... -- 11,678 Consumer........................... 4,796 -- ------- ------- Total........................... $20,375 $83,362 ======= ======= Scheduled contractual principal repayments of loans do not reflect the actual life of such assets. The average life of loans is substantially less than their contractual terms because of prepayments. In addition, due-on-sale clauses on loans generally give the lender the right to declare a loan immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage and the loan is not repaid. The average life of mortgage loans tends to increase when current mortgage loan market rates are substantially higher than rates on existing mortgage loans and, conversely, decrease when current mortgage loan market rates are substantially lower than rates on existing mortgage loans. Originations, Purchases and Sales of Loans. The Bank generally has authority to originate and purchase loans secured by real estate located throughout the United States. Consistent with its emphasis on being a community-oriented financial institution, the Bank conducts substantially all of its lending activities in its market area. The following table sets forth certain information with respect to loan origination activity for the periods indicated. The Bank has not purchased or sold any loans in the periods presented. Year Ended December 31, -------------------------------------- 1999 1998 1997 ---- ---- ---- (In thousands) Loan originations: One-to-four family residential $ 16,474 $ 24,406 $ 14,578 Multi-family residential...... 686 204 1,115 Construction.................. 2,470 1,749 6,302 Non-residential............... 4,970 1,056 372 Consumer...................... 5,922 5,324 7,472 --------- --------- -------- Total loans originated...... 30,522 32,739 29,839 --------- --------- -------- Loan principal reductions: Loan principal repayments..... 25,797 27,403 21,865 --------- --------- -------- Net increase in loan portfolio... $ 4,725 $ 5,336 $ 7,974 ========= ========= ======== Loan originations are derived from a number of sources, including existing customers, referrals by real estate agents, depositors and borrowers and advertising, as well as walk-in customers. Solicitation programs consist of advertisements in local media, in addition to occasional participation in various community organizations and events. Real estate loans are originated by the Bank's loan personnel. All of the loan personnel are salaried, and are not compensated on a commission basis for loans originated. Loan applications are accepted at any of the Bank's branches. Loan Underwriting Policies. Lending activities are subject to written, non-discriminatory underwriting standards and to loan origination procedures prescribed by the Board of Directors and its management. Detailed loan applications are obtained to determine the ability of borrowers to repay, and the more significant items on these applications are verified through the use of credit reports, financial statements and confirmations. All loans must be reviewed by the loan committee, which is comprised of lending officers and branch managers. Exceptions to the 3 underwriting standards must be approved by the loan committee. In addition, the full Board of Directors reviews all loans on a monthly basis. Generally, upon receipt of a loan application from a prospective borrower, a credit report and verifications are ordered to confirm specific information relating to the loan applicant's employment, income and credit standing. If a proposed loan is to be secured by a mortgage on real estate, an appraisal of the real estate is undertaken by an appraiser approved by the Board of Directors and licensed or certified (as necessary) by the Commonwealth of Kentucky. In the case of one-to-four family residential mortgage loans, except when the Bank becomes aware of a particular risk of environmental contamination, the Bank generally does not obtain a formal environmental report on the real estate at the time a loan is made. A formal environmental report may be required in connection with nonresidential real estate loans. It is the Bank's policy to record a lien on the real estate securing a loan and to obtain a title opinion from Kentucky counsel which provides that the property is free of prior encumbrances and other possible title defects. Borrowers must also obtain hazard insurance policies prior to closing and, when the property is in a flood hazard area, pay flood insurance policy premiums. Applications for real estate loans are underwritten and closed in accordance with the Bank's own lending guidelines, which generally do not conform to Federal Home Loan Mortgage Corporation ("FHLMC") and Federal National Mortgage Association ("FNMA") guidelines. Although such loans may not be readily saleable in the secondary market, management believes that, if necessary, such loans may be sold to private investors. The Bank is permitted to lend up to 100% of the appraised value of the real property securing a mortgage loan. The Bank is required by federal regulations to obtain private mortgage insurance on that portion of the principal amount of any loan that is greater than 90% of the appraised value of the property. Under its lending policies, the Bank will originate a one-to-four family residential mortgage loan for owner-occupied property with a loan-to-value ratio of up to 95%. For residential properties that are not owner-occupied, the Bank generally does not lend more than 80% of the appraised value. For all residential mortgage loans, the Bank may increase its lending level on a case-by-case basis, provided that the excess amount is insured with private mortgage insurance. Under applicable law, with certain limited exceptions, loans and extensions of credit outstanding by a savings institution to a person at one time shall not exceed 15% of the institution's unimpaired capital and surplus. Loans and extensions of credit fully secured by readily marketable collateral may comprise an additional 10% of unimpaired capital and surplus. Applicable law additionally authorizes savings institutions to make loans to one borrower, for any purpose, in an amount not to exceed the lesser of $30.0 million or 30% of unimpaired capital and surplus to develop residential housing, provided certain requirements are satisfied. Under these limits, the Bank's loans to one borrower were limited to $6.6 million at December 31, 1999. At that date, the Bank had no lending relationships in excess of the loans-to-one-borrower limit. At December 31,1999, the Bank's largest lending relationship was $2.6 million. The loans are to a local real estate developer and his business associate and are primarily for the development of apartments, the purchase of lots for residential construction, and construction of one-to-four residential housing. All loans within this relationship were current and performing in accordance with their terms at December 31, 1999. Interest rates charged by the Bank on loans are affected principally by competitive factors, the demand for such loans and the supply of funds available for lending purposes. These factors are, in turn, affected by general economic conditions, monetary policies of the federal government, including the Federal Reserve Board, legislative tax policies and government budgetary matters. One-to-four Family Residential Lending. The Bank historically has been and continues to be an originator of one-to-four family residential real estate loans in its market area. At December 31, 1999, one-to-four family residential mortgage loans, totaled approximately $88.2 million, or 76.3% of the Bank's loan portfolio. All loans originated by the Bank are maintained in its portfolio rather than sold in the secondary market. 4 The Bank primarily originates residential mortgage loans with adjustable rates. As of December 31, 1999, 81.7% of one-to-four family mortgage loans in the Bank's loan portfolio carried adjustable rates. Such loans are primarily for terms of 25 years, although the Bank does occasionally originate adjustable rate mortgages for 15, 20 and 30 year terms, in each case amortized on a monthly basis with principal and interest due each month. The interest rates on these mortgages are adjusted once per year, with a maximum adjustment of 1% per adjustment period and a maximum aggregate adjustment of 5% over the life of the loan. A borrower may also obtain a loan in which the maximum annual adjustment is 0.5% with a higher initial rate. Prior to August 1, 1997, rate adjustments on the Bank's adjustable rate loans were indexed to a rate which adjusted annually based upon changes in an index based on the National Monthly Median Cost of Funds, plus a margin of 2.75%. Because the National Monthly Median Cost of Funds is a lagging index, which results in rates changing at a slower pace than rates generally in the marketplace, the Bank has changed to a one-year Treasury bill constant maturity, which the Bank believes reflects more current market information and thus allows the Bank to react more quickly to changes in the interest rate environment. The adjustable rate mortgage loans offered by the Bank also provide for initial rates of interest below the rates that would prevail when the index used for repricing is applied. Such initial rates, also referred to as "teaser rates," often reflect a discount from the prevailing rate greater than the 1.0-% maximum adjustment allowed each year. As a result, the Bank may not be able to restore the interest rate of a loan with a teaser rate to its otherwise initial loan rate until at least the second adjustment period that occurs at the beginning of the third year of the loan. Further, in a rising interest rate environment, the Bank may not be able to adjust the interest rate of the loan to the prevailing market rate until an even later period because of the combination of the teaser discount and the 1% limitation on annual adjustments. The retention of adjustable rate loans in the Bank's portfolio helps reduce the Bank's exposure to increases in prevailing market interest rates. However, there are unquantifiable credit risks resulting from potential increases in costs to borrowers in the event of upward repricing of adjustable-rate loans. It is possible that during periods of rising interest rates, the risk of default on adjustable rate loans may increase due to increases in interest costs to borrowers. Further, although adjustable rate loans allow the Bank to increase the sensitivity of its interest-earning assets to changes in interest rates, the extent of this interest sensitivity is limited by the initial fixed-rate period before the first adjustment and the lifetime interest rate adjustment limitations. This risk is heightened by the Bank's practice of offering its adjustable rate mortgages with a discount to its initial interest rate that is greater than the annual increase in interest rates allowed under the terms of the loan. Accordingly, there can be no assurance that yields on the Bank's adjustable rate loans will fully adjust to compensate for increases in the Bank's cost of funds. Finally, adjustable rate loans increase the Bank's exposure to decreases in prevailing market interest rates, although the 1% limitation on annual decreases in the loans' interest rates tend to offset this effect. The Bank also originates, to a limited extent, fixed-rate loans for terms of 15 years. Such loans are secured by first mortgages on one-to-four family, owner-occupied residential real property located in the Bank's market area. Because of the Bank's policy to mitigate its exposure to interest rate risk through the use of adjustable rate rather than fixed rate products, the Bank does not emphasize fixed-rate mortgage loans. At December 31, 1999, only $15.6 million, or 13.7%, of the Bank's loan portfolio, consisted of fixed-rate mortgage loans. To further reduce its interest rate risk associated with such loans, the Bank may rely upon FHLB advances with similar maturities to fund such loans. See "-- Deposit Activity and Other Sources of Funds -- Borrowing." Neither the fixed rate or the adjustable rate residential mortgage loans of the Bank are originated in conformity with secondary market guidelines issued by FHLMC or FNMA. As a result, such loans may not be readily saleable in the secondary market to institutional purchasers. However, such loans may still be sold to private investors whose investment strategies do not depend upon loans that satisfy FHLMC or FNMA criteria. Further, given its high liquidity, the Bank does not currently view loan sales as a necessary funding source. Construction Lending. The Bank engages in construction lending involving loans to individuals for construction of one-to four- family residential housing located within the Bank's market area, with such loans converting to permanent financing upon completion of construction. Such loans are generally made to individuals for construction primarily in established subdivisions within the Bank's market area. The Bank mitigates its risk with construction loans by imposing a maximum loan-to-value ratio of 95% for homes that will be owner-occupied and 80% for homes being built on a speculative basis. At December 31, 1999, the Bank's loan portfolio included $5.7 million of loans secured by properties under construction, including construction/permanent loans structured to 5 become permanent loans upon the completion of construction and interim construction loans structured to be repaid in full upon completion of construction and receipt of permanent financing. The Bank also makes loans to qualified builders for the construction of one-to-four family residential housing located in established subdivisions in the Bank's market area. Because such homes are intended for resale, such loans are generally not converted to permanent financing at the Bank. All construction loans are secured by a first lien on the property under construction. Loan proceeds are disbursed in increments as construction progresses and as inspections warrant. Construction/permanent loans may have adjustable or fixed interest rates and are underwritten in accordance with the same terms and requirements as the Bank's permanent mortgages. Such loans generally provide for disbursement in stages during a construction period of up to six months, during which period the borrower is required to make payments of interest only. The permanent loans are typically 30-year adjustable rate loans, with the same terms and conditions otherwise offered by the Bank. Monthly payments of principal and interest commence the month following the date the loan is converted to permanent financing. Borrowers must satisfy all credit requirements that would apply to the Bank's permanent mortgage loan financing prior to receiving construction financing for the subject property. Construction financing generally is considered to involve a higher degree of risk of loss than long-term financing on improved, occupied real estate. Risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the property's value at completion of construction or development and the estimated cost (including interest) of construction. During the construction phase, a number of factors could result in delays and cost overruns. If the estimate of construction costs proves to be inaccurate, the Bank may be confronted at or prior to the maturity of the loan, with a project having a value which is insufficient to assure full repayment. The ability of a developer to sell developed lots or completed dwelling units will depend on, among other things, demand, pricing, availability of comparable properties and economic conditions. The Bank has sought to minimize this risk by limiting construction lending to qualified borrowers in the Bank's market area, by requiring the involvement of qualified builders, and by limiting the aggregate amount of outstanding construction loans. Multi-Family Residential and Non-Residential Real Estate Lending. The Bank's multi-family residential loan portfolio consists of adjustable rate loans secured by real estate. At December 31,1999 the Bank had $2.2 million of multi-family residential loans, which amounted to 1.9% of the Bank's loan portfolio at such date. The Bank's non-residential real estate portfolio generally consists of adjustable rate loans secured by first mortgages on residential lots and rental property. In each case, such property is located in the Bank's market area. At December 31, 1999, the Bank had approximately $12.4 million of such loans, which comprised 10.7% of its loan portfolio. Multi-family residential real estate loans are underwritten with loan-to-value ratios up to 80% of the appraised value of the property. Non-residential real estate loans are underwritten with loan-to-value ratios up to 65% of the appraised value for raw land and 75% for land development loans. The Bank currently does not intend to significantly expand multi-family residential or non-residential real estate lending, but may do so if opportunities arise in the future. Multi-family residential and non-residential real estate lending entails significant additional risks as compared with one-to-four family residential property lending. Multi-family residential and commercial real estate loans typically involve larger loan balances to single borrowers or groups of related borrowers. The payment experience on such loans typically is dependent on the successful operation of the real estate project, retail establishment or business. These risks can be significantly impacted by supply and demand conditions in the market for the office, retail and residential space, and, as such, may be subject to a greater extent to adverse conditions in the economy generally. To minimize these risks, the Bank generally limits itself to its market area or to borrowers with which it has prior experience or who are otherwise known to the Bank. It has been the Bank's policy to obtain annual financial statements of the business of the borrower or the project for which multi-family residential real estate or commercial real estate loans are made. Consumer and Other Lending. The consumer loans currently in the Bank's loan portfolio consist of loans secured by savings deposits and other consumer loans. Savings deposit loans are usually made for up to 90% of the depositor's savings account balance. The interest rate is approximately 2.0% above the rate paid on such deposit 6 account serving as collateral, and the account must be pledged as collateral to secure the loan. Interest generally is billed on a quarterly basis. At December 31, 1999, loans on deposit accounts totaled $2.5 million, or 2.2% of the Bank's loan portfolio. Other consumer loans include automobile loans, the amount and terms of which are determined by the loan committee, and home equity and home improvement loans, which are made for up to 95% of the value of the property but require private mortgage insurance on 100% of the value of the property. The Bank is attempting to grow its portfolio of consumer loans. Consumer loans may entail greater credit risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or are secured by rapidly depreciable assets, such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. In addition, consumer loan collections are dependent on the borrower's continuing financial stability, and therefore are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans. At December 31, 1999, there were approximately $7,000 of consumer loans delinquent 90 days or more. There can be no assurance that delinquencies will not increase in the future, particularly in light of the Bank's decision to increase its efforts to originate a higher volume and greater variety of consumer loans. NON-PERFORMING LOANS AND OTHER PROBLEM ASSETS The Bank's non-performing loans totaled .05% of total assets at December 31, 1999. Loans are placed on a non-accrual status when the loan is past due in excess of 90 days and collection of principal and interest is doubtful. The Bank places a high priority on contacting customers by telephone as a primary method of determining the status of delinquent loans and the action necessary to resolve any payment problem. The Bank's management performs quality reviews of problem assets to determine the necessity of establishing additional loss reserves. Real estate acquired by the Bank as a result of foreclosure is classified as real estate owned until such time as it is sold. The Bank generally tries to sell the property at a price no less than its net book value, however, it will consider slight discounts to the appraised value to expedite the return of the funds to an earning status. When such property is acquired, it is recorded at its fair value less estimated costs of sale. Any required write-down of the loan to its appraised fair market value upon foreclosure is charged against the allowance for loan losses. Subsequent to foreclosure, in accordance with generally accepted accounting principles, a valuation allowance is established if the carrying value of the property exceeds its fair value net of related selling expenses. The following table sets forth information with respect to the Bank's non-performing assets at the dates indicated. No loans were recorded as restructured loans within the meaning of SFAS No. 15 at the dates indicated.
At December 31, ---------------------------------------------------------------- 1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- (Dollars in thousands) Accruing loans which are contractually past due 90 days or more: Residential real estate... $ 51 $ 268 $ 140 $ 266 $ 133 Consumer.................. 7 19 23 -- 1 -------- -------- -------- -------- ------- Total................... $ 58 $ 287 $ 163 $ 266 $ 134 -------- -------- -------- -------- ------- Total non-performing loans................. $ 58 $ 287 $ 163 $ 266 $ 134 ======== ======== ======== ======== ======= Percentage of total loans.... 0.05% 0.26% 0.16% 0.28% 0.16% ======== ========= ========= ======== =======
At December 31, 1999, the Bank had no loans accounted for on a non-accrual basis, no other non-performing assets and no real estate owned. 7 At December 31, 1999, the Bank had no loans outstanding which were classified as nonaccrual, 90 days past due or restructured but where known information about possible credit problems of borrowers caused management to have serious concerns as to the ability of the borrowers to comply with present loan repayment terms and may result in disclosure as nonaccrual, 90 days past due or restructured. Also, the Bank had no impaired loans under SFAS 114/118. As such, the impact of adopting these statements was not significant to the Bank. Federal regulations require savings institutions to classify their assets on the basis of quality on a regular basis. An asset meeting one of the classification definitions set forth below may be classified and still be a performing loan. An asset is classified as substandard if it is determined to be inadequately protected by the current retained earnings and paying capacity of the obligor or of the collateral pledged, if any. An asset is classified as doubtful if full collection is highly questionable or improbable. An asset is classified as loss if it is considered uncollectible, even if a partial recovery could be expected in the future. The regulations also provide for a special mention designation, described as assets which do not currently expose a savings institution to a sufficient degree of risk to warrant classification but do possess credit deficiencies or potential weaknesses deserving management's close attention. Such assets designated as special mention may include non-performing loans consistent with the above definition. Assets classified as substandard or doubtful require a savings institution to establish general allowances for loan losses. If an asset or portion thereof is classified loss, a savings institution must either establish a specific allowance for loss in the amount of the portion of the asset classified loss, or charge off such amount. Federal examiners may disagree with a savings institution's classifications. If a savings institution does not agree with an examiner's classification of an asset, it may appeal this determination to the OTS Regional Director. The Bank regularly reviews its assets to determine whether any assets require classification or re-classification. At December 31, 1999, the Bank had $9,922 in assets classified as special mention, $58,026 in assets classified as substandard, no assets classified as doubtful and no assets classified as loss. Special mention assets consist primarily of residential real estate loans secured by first mortgages. This classification is primarily used by management as a "watch list" to monitor loans that exhibit any potential deviation in performance from the contractual terms of the loan. Allowance for Loan Losses. In originating loans, the Bank recognizes that credit losses will be experienced and that the risk of loss will vary with, among other things, the type of loan being made, the creditworthiness of the borrower over the term of the loan, general economic conditions and, in the case of a secured loan, the quality of the security for the loan. It is management's policy to maintain an adequate allowance for loan losses based on, among other things, the Bank's and the industry's historical loan loss experience, evaluation of economic conditions, regular reviews of delinquencies and loan portfolio quality and evolving standards imposed by federal bank examiners. The Bank increases its allowance for loan losses by charging provisions for possible loan losses against the Bank's income. Management will continue to actively monitor the Bank's asset quality and allowance for loan losses. Management will charge off loans and properties acquired in settlement of loans against the allowances for losses on such loans and such properties when appropriate and will provide specific loss allowances when necessary. Although management believes it uses the best information available to make determinations with respect to the allowances for losses and believes such allowances are adequate, future adjustments may be necessary if economic conditions differ substantially from the economic conditions in the assumptions used in making the initial determinations. The Bank's methodology for establishing the allowance for loan losses takes into consideration probable losses that have been identified in connection with specific assets as well as losses that have not been identified but can be expected to occur. Management conducts regular reviews of the Bank's assets and evaluates the need to establish allowances on the basis of this review. Allowances are established by the Board of Directors on a quarterly basis based on an assessment of risk in the Bank's assets taking into consideration the composition and quality of the portfolio, delinquency trends, current charge-off and loss experience, loan concentrations, the state of the real estate market, regulatory reviews conducted in the regulatory examination process and economic conditions generally. Specific reserves will be provided for individual assets, or portions of assets, when ultimate collection is considered improbable by management based on the current payment status of the assets and the fair value of the 8 security. At the date of foreclosure or other repossession, the Bank would transfer the property to real estate acquired in settlement of loans initially at the lower of cost or estimated fair value and subsequently at the lower of book value or fair value less estimated selling costs. Any portion of the outstanding loan balance in excess of fair value less estimated selling costs would be charged off against the allowance for loan losses. If, upon ultimate disposition of the property, net sales proceeds exceed the net carrying value of the property, a gain on sale of real estate would be recorded. Banking regulatory agencies, including the OTS, have adopted a policy statement regarding maintenance of an adequate allowance for loan and lease losses and an effective loan review system. This policy includes an arithmetic formula for determining the reasonableness of an institution's allowance for loan loss estimate compared to the average loss experience of the industry as a whole. Examiners will review an institution's allowance for loan losses and compare it against the sum of: (i) 50% of the portfolio that is classified doubtful; (ii) 15% of the portfolio that is classified as substandard; and (iii) for the portions of the portfolio that have not been classified (including those loans designated as special mention), estimated credit losses over the upcoming 12 months given the facts and circumstances as of the evaluation date. This amount is considered neither a "floor" nor a "safe harbor" of the level of allowance for loan losses an institution should maintain, but examiners will view a shortfall relative to the amount as an indication that they should review management's policy on allocating these allowances to determine whether it is reasonable based on all relevant factors. The following table sets forth an analysis of the Bank's allowance for loan losses for the periods indicated.
Year Ended December 31, -------------------------------------------- 1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- (Dollars in thousands) Balance at beginning of period .......... $ 258 $ 237 $ 217 $ 122 $ 122 Loans charged off: Real estate mortgage: Residential .......................... -- -- -- (5) -- ----- ----- ----- ----- ----- Total charge-offs ....................... -- -- -- (5) -- ----- ----- ----- ----- ----- Recoveries .............................. -- -- -- -- -- ----- ----- ----- ----- ----- Net loans charged off ................... -- -- -- (5) -- ----- ----- ----- ----- ----- Provision for loan losses ............... $ 20 $ 21 20 100 -- ----- ----- ----- ----- ----- Balance at end of period ................ $ 278 $ 258 $ 237 $ 217 $ 122 ===== ===== ===== ===== ===== Ratio of net charge-offs to average loans outstanding during the period ........ 0% 0% 0% 0.0053% 0% ===== ===== ===== ====== =====
The following table sets forth the breakdown of the allowance for loan losses by loan category at the dates indicated. Management believes that the allowance can be allocated by category only on an approximate basis. The allocation of the allowance to each category is not necessarily indicative of future losses and does not restrict the use of the allowance to absorb losses in any category. 9
At December 31, ---------------------------------------------------------------------------------------------------------- 1999 1998 1997 1996 ----------------------- ----------------------- ------------------------ ----------------------- Percent of Percent of Percent of Percent of Loans in Loans in Loans in Loans in Each Each Each Each Category to Category to Category to Category to Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans ------ ----------- ------ ----------- ------ ----------- ------ ----------- (Dollars in thousands) One-to-four family... $ 130 76.3% $ 136 80.6% $ 186 78.7% $ 163 79.6% Construction......... 5 4.9% 7 4.2% 6 4.9% 11 5.6% Multi-family residential 8 1.9% 6 1.4% 12 2.2% 3 1.5% Non-residential...... 85 10.7% 71 7.5% 19 7.2% 23 5.6% Secured by deposits.. -- 2.2% -- 2.1% -- 2.9% -- 3.6% Other consumer loans. 50 4.0% 38 4.2% 14 4.1% 17 4.1% ------ ------ ------ ------ ------ ------- ------- ------ Total allowance for loan losses..... $ 278 100.0% $ 258 100.0% $ 237 100.0% $ 217 100.0% ====== ====== ====== ====== ====== ======= ======= ======
10 At December 31, 1995 --------------------------------------- Percent of Loans in Each Amount Category to Total Loans ------ ----------------------- (In thousands) One-to-four family.......... $ 94 81.5% Construction................ 5 4.7% Multi-family residential.... 1 0.6% Non-residential............. 14 5.9% Secured by deposits......... -- 3.8% Other consumer loans........ 8 3.5% ------- ------ Total allowance for loan losses............ $ 122 100.0% ======= ===== INVESTMENT ACTIVITIES The Bank makes investments in order to maintain the levels of liquid assets required by regulatory authorities and manage cash flow, diversify its assets, obtain yield and to satisfy certain requirements for favorable tax treatment. The investment activities of the Company and the Bank consist primarily of investments in Agency Securities and Mortgage-Backed Securities. Typical investments include federally sponsored agency mortgage pass-through and federally sponsored agency and mortgage-related securities. Investment and aggregate investment limitations and credit quality parameters of each class of investment are prescribed in the Bank's investment policy. The Company and the Bank perform analyses on mortgage-related securities prior to purchase and on an ongoing basis to determine the impact on earnings and market value under various interest rate and prepayment conditions. Securities purchases must be approved by the Bank's President. The Board of Directors reviews all securities transactions on a monthly basis. The principal objective of the investment policy is to earn as high a rate of return as possible, but to consider also financial or credit risk, liquidity risk and interest rate risk. At December 31, 1999, securities with an amortized cost of $72.8 million and an approximate market value of $71.4 million were classified as available for sale. Management presently does not intend to sell such securities and, based on the current liquidity level and the access to borrowings through the FHLB of Cincinnati, management currently does not anticipate that the Company or the Bank will be placed in a position of having to sell securities with material unrealized losses. Securities designated as "held to maturity" are those assets which the Company or the Bank has both the ability and the intent to hold to maturity. Upon acquisition, securities are classified as to the Company's or the Bank's intent, and a sale would only be effected due to deteriorating investment quality. The held to maturity investment portfolio is not used for speculative purposes and is carried at amortized cost. In the event securities are sold from this portfolio for other than credit quality reasons, all securities within the investment portfolio with matching characteristics may be reclassified as assets available for sale. Securities designated as "available for sale" are those assets which the Company or the Bank may not hold to maturity and thus are carried at market value with unrealized gains or losses, net of tax effect, recognized in other comprehensive income. Mortgage-Backed and Related Securities. Mortgage-backed securities represent a participation interest in a pool of one-to-four family or multi-family mortgages, the principal and interest payments on which are passed from the mortgage originators through intermediaries that pool and repackage the participation interest in the form of securities to investors such as the Bank. Such intermediaries may include quasi-governmental agencies such as FHLMC, FNMA and the Government National Mortgage Association ("GNMA") which guarantee the payment of principal and interest to investors. Of the $43.3 million mortgage-backed security portfolio at December 31, 1999, approximately $22.5 million were originated through GNMA, approximately $11.0 million were originated through FNMA and approximately $9.8 million were originated through FHLMC. Mortgage-backed securities generally increase the quality of the assets by virtue of the guarantees that back them, are more liquid than individual mortgage loans and may be used to collateralize borrowings or other obligations of the Bank. 11 Mortgage-backed securities typically are issued with stated principal amounts and the securities are backed by pools of mortgages that have loans with interest rates that are within a range and have similar maturities. The underlying pool of mortgages can be composed of either fixed-rate or adjustable-rate mortgage loans. Mortgage-backed securities generally are referred to as mortgage participation certificates or pass-through certificates. As a result, the interest rate risk characteristics of the underlying pool of mortgages, i.e., fixed-rate or adjustable-rate, as well as prepayment risk, are passed on to the certificate holder. The life of a mortgage-backed pass-through security is equal to the life of the underlying mortgages. The actual maturity of a mortgage-backed security varies, depending on when the mortgagors prepay or repay the underlying mortgages. Prepayments of the underlying mortgages may shorten the life of the investment, thereby adversely affecting its yield to maturity and the related market value of the mortgage-backed security. The yield is based upon the interest income and the amortization of the premium or accretion of the discount related to the mortgage-backed security. Premiums and discounts on mortgage-backed securities are amortized or accreted over the estimated term of the securities using a level yield method. The prepayment assumptions used to determine the amortization period for premiums and discounts can significantly affect the yield of the mortgage-backed security, and these assumptions are reviewed periodically to reflect the actual prepayment. The actual prepayments of the underlying mortgages depend on many factors, including the type of mortgage, the coupon rate, the age of the mortgages, the geographical location of the underlying real estate collateralizing the mortgages and general levels of market interest rates. The difference between the interest rates on the underlying mortgages and the prevailing mortgage interest rates is an important determinant in the rate of prepayments. During periods of falling mortgage interest rates, prepayments generally increase, and, conversely, during periods of rising mortgage interest rates, prepayments generally decrease. If the coupon rate of the underlying mortgage significantly exceeds the prevailing market interest rates offered for mortgage loans, refinancing generally increases and accelerates the prepayment of the underlying mortgages. Prepayment experience is more difficult to estimate for adjustable-rate mortgage-backed securities. The following table sets forth the carrying value of the investment securities at the dates indicated. At December 31, ---------------------------- 1999 1998 1997 ---- ---- ---- (In thousands) Securities available for sale: FHLB and FHLMC stock ........ $ 1,987 $ 9,845 $ 6,895 U. S. government and agency securities (1) ............ 36,120 23,065 13,000 Mortgage-backed securities .. 33,301 35,214 6,789 Other ....................... 15 15 15 Securities held to maturity: U.S. government and agency securities (1) ............ -- 13,997 31,988 Mortgage-backed securities .. 9,958 13,357 19,578 ------- ------- ------- Total investment securities $81,381 $95,493 $78,265 ======= ======= ======= - --------------------------- (1) Primarily reflects debt securities purchased from the FHLB of Cincinnati. The following table sets forth information in the scheduled maturities, amortized cost, market values and average yields for U.S. government and agency securities in the investment portfolio at December 31, 1999. At such date, all of these securities were callable and/or due on or before December 15, 2000.
One Year or Less One to Five Years Five to Ten Years After Ten Years Total Investment Portfolio ---------------- ----------------- ----------------- --------------- -------------------------- Carrying Average Carrying Average Carrying Average Carrying Average Carrying Market Average Value Yield value Yield Yield Value Value Yield Value Value Yield ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- (Dollars in thousands) U.S. government and agency securities $ -- --% $ 15,997 6.29% $ 7,206 6.92% $ 14,209 7.96% $37,412 $36,120 7.04% ======== ======= ======== ===== ======== ===== ======== ===== ======= ======= =====
12 DEPOSIT ACTIVITY AND OTHER SOURCES OF FUNDS GENERAL. Deposits are the primary source of the Bank's funds for lending, investment activities and general operational purposes. In addition to deposits, the Bank derives funds from loan principal and interest repayments, maturities of investment securities and mortgage-backed securities and interest payments thereon. Although loan repayments are a relatively stable source of funds, deposit inflows and outflows are significantly influenced by general interest rates and money market conditions. Borrowings may be used on a short-term basis to compensate for reductions in the availability of funds, or on a longer term basis for general corporate purposes. The Bank has access to borrow from the FHLB of Cincinnati, and the Bank will continue to have access to FHLB of Cincinnati advances. The Bank may rely upon retail deposits rather than borrowings as its primary source of funding for future asset growth. DEPOSITS. The Bank attracts deposits principally from within its market area by offering competitive rates on its deposit instruments, including money market accounts, passbook savings accounts, Individual Retirement Accounts, and certificates of deposit which range in maturity from three months to five years. Deposit terms vary according to the minimum balance required, the length of time the funds must remain on deposit and the interest rate. Maturities, terms, service fees and withdrawal penalties for its deposit accounts are established by the Bank on a periodic basis. The Bank reviews its deposit mix and pricing on a weekly basis. In determining the characteristics of its deposit accounts, the Bank considers the rates offered by competing institutions, lending and liquidity requirements, growth goals and federal regulations. The Bank does not accept brokered deposits. The Bank attempts to compete for deposits with other institutions in its market area by offering competitively priced deposit instruments that are tailored to the needs of its customers. Additionally, the Bank seeks to meet customers' needs by providing convenient customer service to the community. Substantially all of the Bank's depositors are Kentucky residents who reside in the Bank's market area. Savings deposits in the Bank at December 31, 1999 were represented by the various types of savings programs described below.
Percentage Interest Minimum Minimum of Total Rate* Term Category Amount Balance Deposits - ------------ ------------------- ------------------------------ ------------- ------------- ------------ (In thousands) -- % None Non-interest bearing $ 100 $2,943 1.8% 2.5%* None Demand/NOW accounts 1.500 9,017 5.6 2.8% None Passbook accounts 10 9,803 6.1 3.9%* None Money market deposit accounts 2,500 30,063 18.7 -------- ----- 51,826 32.2 -------- ----- Certificates of Deposit ------------------------------ 5.2% 3 months or less Fixed-term, fixed rate 500 19,216 11.9 5.3% Over 3 to 12-months Fixed-term, fixed-rate 500 44,572 27.7 5.7% Over 12 to 24-months Fixed-term, fixed-rate 500 35,294 21.9 5.6% Over 24 to 36-months Fixed-term, fixed-rate 500 4,388 2.8 5.7% Over 36 to 48-months Fixed-term, fixed-rate 500 2,995 1.9 5.6% Over 48 to 60-months Fixed-term, fixed rate 500 2,614 1.6 -------- ----- 109,079 67.8 -------- ----- $160,905 100.0% ======== ======
- ----------------- * Represents weighted average interest rate. 13 The following table sets forth, for the periods indicated, the average balances and interest rates based on month-end balances for interest-bearing demand deposits and time deposits.
Year Ended December 31, -------------------------------------------------------------------------------------------------------- 1999 1998 1997 ------------------------------- -------------------------------- --------------------------------- Interest-bearing Time Interest-bearing Time Interest-bearing Time demand deposits deposits demand deposits deposits demand deposits deposits --------------- -------- --------------- -------- --------------- -------- (Dollars in thousands) Average balance........ $ 49,365 $103,880 $ 62,414 $ 109,508 $ 71,590 $ 123,429 Average rate........... 3.14% 5.37% 3.36% 5.39% 3.51% 5.52%
The following table sets forth the change in dollar amount of deposits in the various types of accounts offered by the Bank between the dates indicated.
Increase Increase Balance at (Decrease) from Balance at (Decrease) from December 31, % of December 31, December 31, % of December 31, 1999 Deposits 1998 1998 Deposits 1997 ---- -------- ---- ---- -------- ---- (Dollars in thousands) Non-interest bearing..... $ 2,943 1.8% $ 212 $ 2,731 1.8% $ 768 Demand and NOW accounts.............. 9,017 5.6% 393 8,624 5.6% (860) Money market............. 30,063 18.7% (709) 30,772 19.9% (11,292) Passbook savings......... 9,803 6.1% (391) 10,194 6.6% (137,886) Other time deposits...... 109,079 67.8% 6,584 102,495 66.1% (16,547) ---------- ------ --------- ---------- -------- ---------- Total................. $ 160,905 100.0% $ 6,089 $ 154,816 100.0% $ (165,817) ========== ====== ========= ========== ======== ==========
(continued)
Balance at Increase Balance at December 31, % of (Decrease) from December 31, % of 1997 Deposits December 31, 1996 1996 Deposits ---- -------- ----------------- ---- -------- (Dollars in thousands) Non-interest bearing..... $ 1,963 0.6% $ 179 $ 1,784 1.0% Demand and NOW accounts.............. 9,484 3.0% 1,881 7,603 4.1% Money market............. 42,064 13.1% 5,124 36,940 20.1% Passbook savings......... 148,080 46.2% 137,448 10,632 5.8% Other time deposits...... 119,042 37.1% (7,826) 126,868 69.0% ---------- -------- --------- --------- ------ Total................. $ 320,633 100.0% $ 136,806 $ 183,827 100.0% ========== ======== ========= ========= ======
The following table sets forth the time deposits in the Bank classified by rates at the dates indicated. 14 At December 31, ----------------------------------------------------- 1999 1998 1997 ---- ---- ---- (In thousands) 2.01 - 4.00%....... $ 211 $ 212 $ 39 4.01 - 6.00%....... 94,719 92,870 102,474 6.01 - 8.00%....... 14,149 9,413 16,529 --------------- ------------- --------- Total............. $ 109,079 $ 102,495 $ 119,042 =============== ============= ========= The following table sets forth the amount and maturities of time deposits at December 31, 1999.
Amount Due ---------------------------------------------------------------------------------------- Less Than One Year 1-2 Years 2-3 Years After 3 Years Total ------------------ --------- --------- ------------- ----- (In thousands) 2.01 - 4.00%.................. $ 211 $ -- $ -- $ -- $ 211 4.01 - 6.00%.................. 56,911 28,210 3,989 5,609 94,719 6.01 - 8.00%.................. 6,666 7,084 399 -- 14,149 ------------- ------------- ----------- ------------- ------------- Total....................... $ 63,788 $ 35,294 $ 4,388 $ 5,609 $ 109,079 ============= ============= =========== ============= =============
The following table indicates the amount of the Bank's certificates of deposit of $100,000 or more by time remaining until maturity as of December 31, 1999. Maturity Period Certificates of Deposit - ------------------------------------- -------------------------- (In thousands) Three months or less................. $ 1,166 Over three through six months........ 1,953 Over six through 12 months........... 2,742 Over 12 months....................... 4,518 -------- Total............................. $ 10,379 ======== Certificates of deposit at December 31, 1999 included approximately $10.4 million of deposits with balances of $100,000 or more, compared to $7.2 million and $8.1 million at December 31, 1998 and 1997, respectively. Such time deposits may be risky because their continued presence in the Bank is dependent partially upon the rates paid by the Bank rather than any customer relationship and, therefore, may be withdrawn upon maturity if another institution offers higher interest rates. The Bank may be required to resort to other funding sources such as borrowings or sales of its securities held available for sale if the Bank believes that increasing its rates to maintain such deposits would adversely affect its operating results. At this time, the Bank does not believe that it will need to significantly increase its deposit rates to maintain such certificates of deposit and, therefore, does not anticipate resorting to alternative funding sources. See Note 5 of Notes to Financial Statements. The following table sets forth the deposit activities of the Bank for the periods indicated.
Year Ended December 31, ------------------------------------------------------ 1999 1998 1997 ---- ---- ---- (In thousands) Deposits............................... $ 314,635 $ 211,652 $ 430,943 Withdrawals............................ (314,279) (383,743) (301,475) ---------- ---------- ----------- Net increase (decrease) before interest credited................... 356 (172,091) 129,468 Interest credited...................... 5,733 6,274 7,338 ---------- ---------- ----------- Net increase (decrease) in savings deposits............................ $ 6,089 $ (165,817) $ 136,806 ========== =========== ===========
In the unlikely event the Bank is liquidated after the Conversion, depositors will be entitled to full payment of their deposit accounts prior to any payment being made to the sole stockholder of the Bank, which is the Company. 15 BORROWINGS. Savings deposits historically have been the primary source of funds for the Bank's lending, investments and general operating activities. The Bank is authorized, however, to use advances from the FHLB of Cincinnati to supplement its supply of lendable funds and to meet deposit withdrawal requirements. The FHLB of Cincinnati functions as a central reserve bank providing credit for savings institutions and certain other member 16 financial institutions. As a member of the FHLB System, the Bank is required to own stock in the FHLB of Cincinnati and is authorized to apply for advances. Advances are pursuant to several different programs, each of which has its own interest rate and range of maturities. The Bank has entered into a Cash Management Advance program with FHLB. See Note 6 of Notes to Financial Statements. Advances from the FHLB of Cincinnati are secured by FHLB investment securities. SUBSIDIARY ACTIVITIES As a federally chartered savings bank, the Bank is permitted to invest an amount equal to 2% of its assets in subsidiaries, with an additional investment of 1% of assets where such investment serves primarily community, inner-city and community development purposes. The Bank does not have any subsidiaries. COMPETITION The Bank faces significant competition both in originating mortgage and other loans and in attracting deposits. The Bank competes for loans principally on the basis of interest rates, the types of loans it originates, the deposit products it offers and the quality of services it provides to borrowers. The Bank also competes by offering products which are tailored to the local community. Its competition in originating real estate loans comes primarily from other savings institutions, commercial banks and mortgage bankers making loans secured by real estate located in the Bank's market area. Commercial banks, credit unions and finance companies provide vigorous competition in consumer lending. Competition may increase as a result of the continuing reduction of restrictions on the interstate operations of financial institutions. The Bank attracts its deposits through its five offices primarily from the local community. Consequently, competition for deposits is principally from other savings institutions, commercial banks and brokers in the local community as well as from credit unions. The Bank competes for deposits and loans by offering what it believes to be a variety of deposit accounts at competitive rates, convenient business hours, a commitment to outstanding customer service and a well-trained staff. The Bank believes it has developed strong relationships with local realtors and the community in general. The Bank is a community and retail-oriented financial institution. Management considers the Bank's branch network and reputation for financial strength and quality customer service as its major competitive advantage in attracting and retaining customers in its market area. A number of the Bank's competitors have been acquired by statewide/nationwide banking organizations. While the Bank is subject to competition from other financial institutions which may have greater financial and marketing resources, management believes the Bank benefits by its community orientation and its long-standing relationship with many of its customers. EMPLOYEES As of December 31, 1999, the Company and the Bank had 29 full-time and 5 part-time employees, none of whom were represented by a collective bargaining agreement. Management considers the Bank's relationships with its employees to be good. REGULATION GENERAL. The Bank is chartered as a federal savings bank under the Home Owners' Loan Act, as amended (the "HOLA"), which is implemented by regulations adopted and administered by the OTS. As a federal savings bank, the Bank is subject to regulation, supervision and regular examination by the OTS. The OTS also has extensive enforcement authority over all savings institutions and their holding companies, including the Bank and the Company. Federal banking laws and regulations control, among other things, the Bank's required reserves, investments, loans, mergers and consolidations, payment of dividends and other aspects of the Bank's operations. The deposits of the Bank are insured by the SAIF administered by the FDIC to the maximum extent provided by law. In addition, the FDIC has certain regulatory and examination authority over OTS-regulated savings institutions and may recommend enforcement actions against savings institutions to the OTS. The supervision and regulation of the Bank is intended primarily for the protection of the deposit insurance fund and the Bank's depositors rather than for holders of the Company's stock or for the Company as the holder of the stock of the Bank. 17 As a savings and loan holding company, the Company is registered with the OTS and subject to OTS regulation and supervision under the HOLA. The Company also is required to file certain reports with, and otherwise comply with the rules and regulations of, the Commission under the federal securities laws. The following discussion is intended to be a summary of certain statutes, rules and regulations affecting the Bank and the Company. A number of other statutes and regulations have an impact on their operations. The following summary of applicable statutes and regulations does not purport to be complete and is qualified in its entirety by reference to such statutes and regulations. FINANCIAL MODERNIZATION LEGISLATION. On November 12, 1999, the Gramm-Leach-Bliley Act of 1999 (the "GLB Act") was enacted into law. The GLB Act makes sweeping changes in the authorized activities of banks and their holding companies. In particular, the GLBA Act repealed the Glass-Steagall Act, which had generally prevented banks from affiliating with securities firms, and also permitted bank holding companies for the first time to affiliate with insurance companies. A new "financial holding company," which owns only well capitalized and well-managed banks, will be permitted to engage in a variety of financial activities, including insurance and securities underwriting and insurance agency activities. The financial holding company provisions of the GLB Act are not expected to have a material effect on the Company or the Bank. The GLB Act also places substantial restrictions on the activities of companies that apply to become savings and loan holding companies after May 4, 1999. However, the GLB Act permits unitary savings and loan holding companies in existence on May 4, 1999, including the Company, to continue to engage in all activities that they were permitted to engage in prior to the enactment of the Act. Under such authority, the Company's business powers are essentially unlimited, provided that the Bank remains a qualified thrift lender. However, the GLB Act further provides that a unitary thrift holding company in existence on May 4, 1999, will lose its exempt status if it or its subsidiary thrift is sold to any unaffiliated company other than another grandfathered unitary thrift holding company. The GLB Act is not expected to have a material effect on the activities in which the Company and the Bank currently engage, except to the extent that competition with banks and bank holding companies may increase as they engage in activities not permitted prior to enactment of the GLB Act. In addition, the GLB Act adopts a number of consumer protections, including provisions intended to protect privacy of bank customers' financial information and new requirements for the disclosure of ATM fees imposed by banks on customers of other banks. Most of the GLB Act's provisions have delayed effective dates and require the adoption of implementing regulations to implement the statutory provisions. Accordingly, at this time the Bank is unable to predict the eventual impact of the Act on its operations. REGULATION OF THE BANK BUSINESS ACTIVITIES. The Bank derives its lending and investment powers from the HOLA and the regulations of the OTS thereunder. Under these laws and regulations, the Bank may invest in mortgage loans secured by residential and commercial real estate, commercial and consumer loans, certain types of commercial paper and debt securities, and certain other assets. The Bank may also establish service corporations that may engage in activities not otherwise permissible for the Bank, including certain real estate equity investments and securities and insurance brokerage. These investment powers are subject to various limitations. BRANCHING. Subject to certain limitations, OTS regulations currently permit a federally chartered savings institution like the Bank to establish branches in any state of the United States, provided that the federal savings institution qualifies as a "domestic building and loan association" under the Internal Revenue Code. See "-- Qualified Thrift Lender Test." The authority for a federal savings institution to establish an interstate branch network would facilitate a geographic diversification of the institution's activities. REGULATORY CAPITAL. The OTS' capital adequacy regulations require savings institutions such as the Bank to meet three minimum capital standards: a "core" capital requirement of 4% of adjusted total assets (or 3% if the institution is rated Composite 1 under the CAMELS examination rating system), a "tangible" capital requirement of 18 1.5% of adjusted total assets, and a "risk-based" capital requirement of 8% of total risk-based capital to total risk-weighted assets. In addition, the OTS has adopted regulations imposing certain restrictions on savings institutions that have a total risk-based capital ratio of less than 8%, a ratio of Tier 1 capital to risk-weighted assets of less than 4% or a ratio of Tier 1 capital to total assets of less than 4%. See "-- Prompt Corrective Regulatory Action." The core capital, or "leverage ratio," requirement mandates that most savings institutions maintain core capital equal to at least 3% of adjusted total assets. "Core capital" includes common stockholders' equity (including retained earnings), noncumulative perpetual preferred stock and related surplus, minority interests in the equity accounts of fully consolidated subsidiaries and certain nonwithdrawable accounts and pledged deposits and is generally reduced by the amount of the savings institution's intangible assets, with limited exceptions for permissible mortgage servicing rights ("MSRs") and purchased credit card relationships. Core capital is further reduced by the amount of a savings institution's investments in and loans to subsidiaries engaged in activities not permissible for national banks. At December 31, 1999, the Bank had no such investments. The risk-based capital standards of the OTS require maintenance of core capital equal to at least 4% of risk-weighted assets and total capital equal to at least 8% of risk-weighted assets. For purposes of the risk-based capital requirement, "total capital" includes core capital plus supplementary capital, provided that the amount of supplementary capital does not exceed the amount of core capital. Supplementary capital includes preferred stock that does not qualify as core capital, nonwithdrawable accounts and pledged deposits to the extent not included in core capital, perpetual and mandatory convertible subordinated debt and maturing capital instruments meeting specified requirements and a portion of the institution's loan and lease loss allowance. The risk-based capital requirement is measured against risk-weighted assets, which equal the sum of each asset and the credit-equivalent amount of each off-balance sheet item after being multiplied by an assigned risk weight, which range from 0% to 100% as assigned by the OTS capital regulations based on the risks the OTS believes are inherent in the type of asset. Comparable risk weights are assigned to off-balance sheet assets. The OTS risk-based capital regulation also includes an interest rate risk ("IRR") component that requires savings institutions with greater than normal IRR, when determining compliance with the risk-based capital requirements, to maintain additional total capital. The OTS has, however, indefinitely deferred enforcement of its IRR requirements. The following table sets forth the Bank's compliance with its regulatory capital requirements at December 31, 1999.
The Bank's Capital Capital Requirements Excess Capital ----------------------- ---------------------- ---------------------- Amount Percent Amount Percent Amount Percent ------ ------- ------ ------- ------ ------- (Dollars in thousands) Tangible capital.............. $ 44,971 21.6% $ 3,123 1.5% $ 41,848 20.1% Core capital.................. $ 44,971 21.6% $ 8,327 4.0% $ 36,644 17.6% Total risk-based capital...... $ 45,249 58.6% $ 6,177 8.0% $ 39,072 50.6%
PROMPT CORRECTIVE REGULATORY ACTION. Under the OTS prompt corrective action regulations, the federal banking regulators are required to take prompt corrective action in respect of depository institutions that do not meet certain minimum capital requirements, including a leverage limit and a risk-based capital requirement. All institutions, regardless of their capital levels, are restricted from making any capital distribution or paying any management fees that would cause the institution to become undercapitalized. The federal banking regulators, including the OTS, have issued regulations that classify insured depository institutions by capital levels and provide that the applicable agency will take various prompt corrective actions to resolve the problems of any institution that fails to satisfy the capital standards. 19 Under the joint prompt corrective action regulations, a "well-capitalized" institution is one that is not subject to any regulatory order or directive to meet any specific capital level and that has or exceeds the following capital levels: a total risk-based capital ratio of 10%, a Tier 1 risk-based capital ratio of 6%, and a ratio of Tier 1 capital to total assets ("leverage ratio") of 5%. An "adequately capitalized" institution is one that does not qualify as "well capitalized" but meets or exceeds the following capital requirements: a total risk-based capital of 8%, a Tier 1 risk-based capital ratio of 4%, and a leverage ratio of either (i) 4% or (ii) 3% if the institution has the highest composite examination rating. An institution not meeting these criteria is treated as "undercapitalized," "significantly undercapitalized," or "critically undercapitalized" depending on the extent to which its capital levels are below these standards. An institution that fails within any of the three "undercapitalized" categories will be subject to certain severe regulatory sanctions required by OTS regulations. As of December 31, 1999, the Bank was "well-capitalized" as defined by the regulations. FEDERAL DEPOSIT INSURANCE. The FDIC has adopted a risk-based insurance assessment system for determining the deposit insurance assessments to be paid by insured depository institutions. The FDIC assigns an institution to one of three capital categories based on the institution's financial information, as of the reporting period ending seven months before the assessment period, consisting of (1) well capitalized, (2) adequately capitalized or (3) undercapitalized, and one of three supervisory subcategories within each capital group. The supervisory subgroup to which an institution is assigned is based on a supervisory evaluation provided to the FDIC by the institution's primary federal regulator and information that the FDIC determines to be relevant to the institution's financial condition and the risk posed to the deposit insurance funds. Assessment rates for SAIF-member institutions like the Bank depend on the capital category and supervisory category to which they are assigned and currently range from 0 basis points to 27 basis points. In addition, all FDIC-insured institutions are required to pay assessments to the FDIC to help fund interest payments on certain bonds issued by the Financing Corporation ("FICO"), an agency of the federal government established to recapitalize the predecessor to the SAIF. The assessment rate for FICO bond servicing is approximately .0216% of insured deposits for the year 2000. The Federal Deposit Insurance Act also provides that the FDIC may not assess regular insurance assessments for the SAIF unless required to maintain or to achieve the designated reserve ratio of 1.25%, except for such assessments on those institutions that are not classified as "well-capitalized" or that have been found to have "moderately severe" or "unsatisfactory" financial, operational or compliance weaknesses. The Bank is classified as "well-capitalized" and has not been found by the OTS to have such supervisory weaknesses. QUALIFIED THRIFT LENDER TEST. The HOLA and OTS regulations require all savings institutions to satisfy one of two Qualified Thrift Lender ("QTL") tests or to suffer a number of sanctions, including restrictions on activities. To qualify as a QTL, a savings institution must either (i) be deemed a "domestic building and loan association" under the Internal Revenue Code (the "Code") by maintaining at least 60% of its total assets in specified types of assets, including cash, certain government securities, loans secured by and other assets related to residential real property, educational loans, and investments in premises of the institution or (ii) satisfy the HOLA's QTL test by maintaining at least 65% of "portfolio assets" in certain "Qualified Thrift Investments." For purposes of the HOLA's QTL test, portfolio assets are defined as total assets less intangibles, property used by a savings institution in its business and liquidity investments in an amount not exceeding 20% of assets. Qualified Thrift Investments consist of (a) loans, equity positions or securities related to domestic, residential real estate or manufactured housing, (b) 50% of the dollar amount of residential mortgage loans subject to sale under certain conditions, and (c) loans to small businesses, student loans and credit card loans. In addition, subject to a 20% of portfolio assets limit, savings institutions are able to treat as Qualified Thrift Investments 200% of their investments in loans to finance "starter homes" and loans for construction, development or improvement of housing and community service facilities or for financing small business in "credit needy" areas. A savings institution must maintain its status as a QTL on a monthly basis in at least nine out of every 12 months. An initial failure to qualify as a QTL results in a number of sanctions, including the imposition of certain operating restrictions and a restriction on obtaining additional advances from its Federal Home Loan Bank. If a savings institution does not requalify under the QTL test within the three-year period after it fails the QTL test, it would be required to terminate any activity not permissible for a national bank and repay as promptly as possible any outstanding advances from its Federal Home Loan Bank. In addition, the holding company of such an institution, such as the Company, would similarly be required to register as a bank holding company with the Federal Reserve Board. At December 31, 1999, the Bank qualified as a QTL. 20 SAFETY AND SOUNDNESS STANDARDS. The FDI Act requires the federal banking agencies, including the OTS, to prescribe for all insured depository institutions standards relating to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, asset quality and compensation, fees and benefits and such other operational and managerial standards as the agencies deem appropriate. The federal banking agencies have adopted final regulations and Interagency Guidelines Establishing Standards for Safety and Soundness ("Guidelines") to implement safety and soundness standards pursuant to the statute. The Guidelines set forth the safety and soundness standards that the federal 21 banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. The Guidelines address internal controls and information systems; internal audit system; credit underwriting; loan documentation; interest rate risk exposure; asset growth; asset quality; earnings; and compensation, fees and benefits. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the Guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard, as required by the FDI Act. The final regulations establish deadlines for the submission and review of such safety and soundness compliance plans. LIMITATIONS ON CAPITAL DISTRIBUTIONS. OTS regulations impose limitations upon capital distributions by savings institutions, such as cash dividends, payments to repurchase or otherwise acquire its shares, payments to stockholders of another institution in a cash-out merger and other distributions charged against capital. A savings institution must give notice to the OTS at least 30 days before declaration of a proposed capital distribution to its holding company, and capital distributions in excess of specified earnings or by certain institutions are subject to approval by the OTS. Under the OTS capital distribution regulations, a savings institution that (i) qualifies for expedited treatment of applications by maintaining one of the two highest supervisory examination ratings, (ii) will be at least adequately capitalized after the proposed capital distribution and (iii) and is not otherwise restricted by applicable law in making capital distributions may, without prior approval by the OTS, make capital distributions during a calendar year equal to its net income for such year plus its retained net income for the preceding two years. Capital distributions in excess of such amount would require prior OTS approval. Under OTS regulations, the Bank would not be permitted to pay dividends on its capital stock if its regulatory capital would thereby be reduced below the amount then required for the liquidation account established for the benefit of certain depositors of the Bank at the time of the Conversion. In addition, under the prompt corrective action regulations of the OTS, the Bank would be prohibited from paying dividends if the Bank were classified as "undercapitalized" under such rules. See "-- Prompt Corrective Regulatory Action." In addition to the foregoing, earnings of the Bank appropriated to bad debt reserves and deducted for federal income tax purposes are not available for payment of dividends or other distributions to the Company without payment of taxes at the then current tax rate by the Bank on the amount of earnings removed from the reserves for such distributions. See "Taxation." TRANSACTIONS WITH AFFILIATES. The Bank is subject to restrictions imposed by Sections 23A and 23B of the Federal Reserve Act on extensions of credit to, and certain other transactions with, the Company and other affiliates, and on investments in the stock or other securities thereof. Such restrictions prevent the Company and such other affiliates from borrowing from the Bank unless the loans are secured by specified collateral, and require such transactions to have terms comparable to terms of arms-length transactions with third persons. Further, such secured loans and other transactions and investments by the Bank are generally limited in amount as to the Company and as to any other affiliate to 10% of the Bank's capital and surplus and as to the Company and all other affiliates to an aggregate of 20% of the Bank's capital and surplus. These restrictions may limit the Company's ability to obtain funds from the Bank for its cash needs, including funds for acquisitions and for payment of dividends, interest and operating expenses. RESERVE REQUIREMENTS. Pursuant to regulations of the Federal Reserve Board (the "FRB"), all FDIC-insured depository institutions must maintain average daily reserves against their transaction accounts. No reserves are required to be maintained on the first $5.0 million of transaction accounts, and reserves equal to 3% must be maintained on the next $44.3 million of transaction accounts, plus reserves equal to 10% on the remainder. These percentages are subject to adjustment by the FRB. Because required reserves must be maintained in the form of vault cash or in a non-interest-bearing account at a Federal Reserve Bank, the effect of the reserve requirement is to reduce the amount of the institution's interest-earning assets. As of December 31, 1999, the Bank met its reserve requirements. LIQUIDITY REQUIREMENTS. The Bank is required by OTS regulation to maintain an average daily balance of liquid assets (cash, certain time deposits, bankers' acceptances, highly rated corporate debt and commercial paper, qualifying mortgage-related securities and mortgage loans, securities of certain mutual funds, and specified United States government, state or federal agency obligations) equal to the monthly average of not less than a specified 22 percentage (currently 4%) of its net withdrawable accounts plus short-term borrowings. The average daily liquidity ratio of the Bank for the month ended December 31, 1999 was 58.0%. FEDERAL HOME LOAN BANK SYSTEM. The Federal Home Loan Bank System consists of 12 district Federal Home Loan Banks subject to supervision and regulation by the Federal Housing Finance Board ("FHFB"). The Federal Home Loan Banks provide a central credit facility primarily for member institutions. As a member of the FHLB, the Bank is required to acquire and hold shares of capital stock in the FHLB in an amount at least equal to 1% of the aggregate unpaid principal of its home mortgage loans, home purchase contracts, and similar obligations at the beginning of each year, or 1/20 of its advances (borrowings) from the FHLB, whichever is greater. The Bank was in compliance with this requirement, with an investment in FHLB stock at December 31, 1999 of $2.0 million. Banks and savings associations generally may obtain long-term FHLB advances only for the purpose of providing funds for residential housing finance; however, depository institutions with less than $500 million in assets may also obtain such financing for use in small business and small farm lending. At December 31, 1999, the Bank had no advances outstanding from the FHLB. REGULATION OF THE COMPANY The Company is a savings and loan holding company under the HOLA and, as such, is subject to OTS regulation, supervision and examination. In addition, the OTS has enforcement authority over the Company and its non-savings institution subsidiaries and may restrict or prohibit activities that are determined to represent a serious risk to the safety, soundness or stability of the Bank or any other subsidiary savings institution. Under the HOLA, a savings and loan holding company is required to obtain the prior approval of the OTS before acquiring another savings institution or savings and loan holding company. A savings and loan holding company may not (i) acquire, with certain exceptions, more than 5% of a non-subsidiary savings institution or a non-subsidiary savings and loan holding company; or (ii) acquire or retain control of a depository institution that is not insured by the FDIC. In addition, while the Bank generally may acquire a savings institution by merger in any state without restriction by state law, the Company could acquire control of an additional savings institution in a state other than Kentucky only if such acquisition is permitted under the laws of the target institution's home state. As a unitary savings and loan holding company, grandfathered under the GLB Act, the Company generally is not subject to any restriction as to the types of business activities in which it may engage, provided that the Bank continues to satisfy the QTL test. See "Regulation - Financial Modernization Legislation" and "-- Regulation and Supervision of the Bank -- Qualified Thrift Lender Test." Upon any non-supervisory acquisition by the Company of another savings institution that is held as a separate subsidiary, the Company would become a multiple savings and loan holding company and would be subject to limitations on the types of business activities in which it could engage. The HOLA limits the activities of a multiple savings and loan holding company and its non-insured institution subsidiaries primarily to activities permissible for financial holding companies under the Bank Holding Company Act, subject to the prior approval of the OTS, and to other activities authorized by OTS regulation. 23 FORWARD-LOOKING STATEMENTS This Annual Report on Form 10-K, including all documents incorporated herein by reference, contains forward-looking statements. Additional written or oral forward-looking statements may be made by the Company from time to time in filings with the Securities and Exchange Commission or otherwise. The words "believe," "expect," "seek," and "intend" and similar expressions identify forward-looking statements, which speak only as of the date the statement is made. Such forward-looking statements are within the meaning of that term in Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such statements may include, but are not limited to, projections of income or loss, expenditures, acquisitions, plans for future operations, financing needs or plans relating to services of the Company, as well as assumptions relating to the foregoing. Forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified. Future events and actual results could differ materially from those set forth in, contemplated by or underlying the forward-looking statements. The Company does not undertake, and specifically disclaims, any obligation to publicly release the results of revisions which may be made to forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. 24 ITEM 2. PROPERTIES The following table sets forth information regarding the Bank's offices at December 31, 1999.
Approximate Year Opened Owned or Leased Book Value (1) Square Footage of Office ----------- --------------- -------------- ------------------------ MAIN OFFICE: (In thousands) 2700 Fort Campbell Boulevard Hopkinsville, Kentucky 42240..... 1995 Owned $ 1,764 16,575 BRANCH OFFICES: Downtown Branch Office 605 South Virginia Street Hopkinsville, Kentucky ....... 1997 Owned $ 165 756 Murray Branch Office 7th and Main Streets Murray, Kentucky............... 1969 Owned $ 64 4,800 Cadiz Branch Office 352 Main Street Cadiz, Kentucky .............. 1998 Owned $ 422 2,200 Elkton Branch Office West Main Street Elkton, Kentucky ............ 1976 Owned $ 57 3,400 ----------- $ 2,472
- ---------------------- (1) Represents the book value of land, building, furniture, fixtures and equipment owned by the Bank. ITEM 3. LEGAL PROCEEDINGS From time to time, the Company or the Bank is a party to various legal proceedings incident to its business. At December 31, 1999, there were no legal proceedings to which the Company or the Bank was a party, or to which any of their property was subject, which were expected by management to result in a material loss to the Company or the Bank. There are no pending regulatory proceedings to which the Company or the Bank is a party or to which any of their properties is subject which are currently expected to result in a material loss. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. EXECUTIVE OFFICERS OF THE REGISTRANT BRUCE THOMAS. Mr. Thomas, 62, has served as President and Chief Executive Officer of the Bank since 1992. He has been an employee of the Bank since 1962. Mr. Thomas also serves as President and Chief Executive Officer of the Company. Effective May 5, 2000, Mr. Thomas will retire as an officer and director of each of the Company and the Bank. PEGGY R. NOEL. Ms. Noel, 61, has served as Executive Vice President, Chief Financial Officer and Chief Operations Officer of the Bank since 1990. She has been an employee of the Bank since 1966. Ms. Noel also serves as Vice President, Chief Financial Officer and Treasurer of the Company. 25 BOYD M. CLARK. Mr. Clark, 54, has served as Senior Vice President -- Loan Administration of the Bank since 1995. Prior to his current position, Mr. Clark served as First Vice President of the Bank. He has been an employee of the Bank since 1973. Mr. Clark also serves as Vice President and Secretary of the Company. Effective May 5, 2000, Mr. Clark will become Acting President of each of the Company and the Bank. 26 All officers serve at the discretion of the boards of directors of the Company or the Bank. There are no known arrangements or understandings between any officer and any other person pursuant to which he or she was or is to be selected as an officer. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. The information set forth under the caption "Market and Dividend Information" in the Company's Annual Report to Stockholders for the year ended December 31, 1999 (Exhibit No. 13) is incorporated herein by reference. ITEM 6. SELECTED FINANCIAL DATA The information set forth under the caption "Selected Financial Information and Other Data" in the Company's Annual Report to Stockholders for the year ended December 31, 1999 (Exhibit No. 13) is incorporated herein by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information set forth under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's Annual Report to Stockholders for the year ended December 31, 1999 (Exhibit No. 13) is incorporated herein by reference. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information set forth under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations - Interest Rate Sensitivity Analysis" in the Company's Annual Report to Stockholders for the year ended December 31, 1999 (Exhibit No. 13) is incorporated herein by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Bank's Financial Statements together with the related notes and the report of York, Neel & Co. - Hopkinsville, LLP, independent public accountants, all as set forth in the Company's Annual Report to Stockholders for the year ended December 31, 1999 (Exhibit No. 13) are incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information regarding directors of the Company is omitted from this Report as the Company has filed a definitive proxy statement (the "Proxy Statement"), and the information included therein under "Proposal I -- Election of Directors" is incorporated herein by reference. Information regarding the executive officers of the Company is included under separate caption in Part I of this Form 10-K 27 ITEM 11. EXECUTIVE COMPENSATION Information regarding executive compensation is omitted from this Report as the Company has filed the Proxy Statement, and the information included therein under "Proposal I -- Election of Directors" is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information required by this Item is omitted from this Report as the Company has filed the Proxy Statement, and the information included therein under "Voting Securities and Principal Holders Thereof" and "Proposal I - Election of Directors" is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information required by this Item is omitted from this Report as the Company has filed the Proxy Statement, and the information included therein under "Proposal I -- Election of Directors" is incorporated herein by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a)(1) The following consolidated financial statements of the Company included in the Annual Report to Stockholders for the year ended December 31, 1999, are incorporated herein by reference in Item 8 of this Report. The remaining information appearing in the Annual Report to Stockholders is not deemed to be filed as part of this Report, except as expressly provided herein. 1. Independent Auditor's Report. 2. Statements of Financial Condition - December 31, 1999 and 1998. 3. Statements of Income for the Years Ended December 31, 1999, 1998 and 1997. 4. Statements of Changes in Stockholders' Equity for the Years Ended December 31, 1999, 1998 and 1997. 5. Statements of Cash Flows for the Years Ended December 31, 1999, 1998 and 1997. 6. Notes to Financial Statements. (a)(2) All schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted. (a)(3) The following exhibits either are filed as part of this Report or are incorporated herein by reference: Exhibit No. 2. Plan of Conversion of Hopkinsville Federal Savings Bank. Incorporated herein by reference to Exhibit No. 2 to Registrant's Registration Statement on Form S-1 (File No. 333-30215). Exhibit No. 3.1. Certificate of Incorporation. Incorporated herein by reference to Exhibit No. 3.1 to Registrant's Registration Statement on Form S-1 (File No. 333-30215). Exhibit No. 3.2. Bylaws. Incorporated herein by reference to Exhibit No. 3.2 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1998. 28 Exhibit No. 10.1. Employment Agreements by and between Hopkinsville Federal Savings Bank and Bruce Thomas, Peggy R. Noel and Boyd M. Clark. Incorporated herein by reference to Exhibit No. 10.1 to Registrant's Registration Statement on Form S-1 (File No. 333-30215). Exhibit No. 10.2. Employment Agreements by and between HopFed Bancorp, Inc. and Bruce Thomas, Peggy R. Noel and Boyd M. Clark. Incorporated herein by reference to Exhibit No. 10.2 to Registrant's Registration Statement on Form S-1 (File No. 333-30215). Exhibit No. 10.3. Employment Agreement Amendments by and between Hopkinsville Federal Savings Bank and Bruce Thomas, Peggy R. Noel and Boyd M. Clark. Incorporated herein by reference to Exhibit No. 10.3 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1998. Exhibit No. 10.4. Employment Agreement Amendments by and between HopFed Bancorp, Inc. and Bruce Thomas, Peggy R. Noel and Boyd M. Clark. Incorporated herein by reference to Exhibit 10.4 to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1998. Exhibit No. 10.5. HopFed Bancorp, Inc. Management Recognition Plan. Incorporated herein by reference to Exhibit 99.1 to Registration Statement on Form S-8 (File No. 333-79391). Exhibit No. 10.6. HopFed Bancorp, Inc. 1999 Stock Option Plan. Incorporated herein by reference to Exhibit 99.2 to Registration Statement on Form S-8 (File No. 333-79391). Exhibit No. 13. Annual Report to Stockholders Except for those portions of the Annual Report to Stockholders for the year ended December 31, 1999, which are expressly incorporated herein by reference, such Annual Report is furnished for the information of the Commission and is not to be deemed "filed" as part of this Report. Exhibit No. 21. Subsidiaries of the Registrant. Exhibit No. 27. Financial Data Schedule (SEC use only) (b) Current Report on Form 8-K dated November 17, 1999, reporting under Item 5 the approval of a special cash dividend of $4.00 per share. Current Report on Form 8-K dated December 15, 1999, reporting under Item 5 the approval of the termination of the Employee Stock Ownership Plan, effective December 31, 1999. (c) Exhibits to this Form 10-K are attached or incorporated by reference as stated above. (d) None. 29 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on behalf by the undersigned, thereunto duly authorized. HOPFED BANCORP, INC. (Registrant) Date: April 14, 2000 By: /s/ Bruce Thomas --------------------- Bruce Thomas President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated and on the dates indicated. DATE: SIGNATURE AND TITLE: /s/ Bruce Thomas April 14, 2000 - -------------------------------------------- Bruce Thomas Director, President and Chief Executive Officer (Principal Executive Officer) /s/ Peggy R. Noel April 14, 2000 - -------------------------------------------- Peggy R. Noel Director, Vice President, Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer) /s/ WD Kelley April 14, 2000 - -------------------------------------------- WD Kelley Chairman of the Board /s/ Boyd M. Clark April 14, 2000 - -------------------------------------------- Boyd M. Clark Director, Vice President and Secretary /s/ Clifton H. Cochran April 14, 2000 - -------------------------------------------- Clifton H. Cochran Director /s/ Walton G. Ezell April 14, 2000 - -------------------------------------------- Walton G. Ezell Director 30 /s/ Gilbert E. Lee April 14, 2000 - -------------------------------------------- Gilbert E. Lee Director /s/ Harry J. Dempsey April 14, 2000 - -------------------------------------------- Harry J. Dempsey Director 31 EX-13 2 ANNUAL REPORT OF HOPFED BANCORP, INC. HOPFED BANCORP, INC. [LOGO] ANNUAL REPORT 1999 HOPFED BANCORP, INC. - -------------------------------------------------------------------------------- HopFed Bancorp, Inc., a Delaware corporation (the "Company"), was organized by Hopkinsville Federal Savings Bank (the "Bank") for the purpose of serving as the holding company of the Bank. On February 6, 1998, the Bank converted from mutual to stock form as a wholly owned subsidiary of the Company. In conjunction with the conversion, the Company issued and sold 4,033,625 shares of its common stock (the "Common Stock") at a price of $10.00 per share (the "Purchase Price"). The Company is classified as a unitary savings and loan holding company subject to regulation by the Office of Thrift Supervision ("OTS") of the Department of the Treasury. The primary activity of the Company is overseeing the business of the Bank and investing the portion of the net proceeds retained by it from the sale of Common Stock. The Bank is a federal stock savings bank headquartered in Hopkinsville, Kentucky, with branch offices in Hopkinsville, Murray, Cadiz and Elkton, Kentucky. The Bank was incorporated in 1879 as a Kentucky chartered building and loan association. In 1940, the Bank converted to a federal charter and obtained federal insurance of accounts. In 1983, the Bank became a federal mutual savings bank and adopted its current corporate title. The business of the Bank primarily consists of attracting deposits from the general public and investing such deposits in loans secured by one-to-four residential properties. The executive offices of the Company and the Bank are located at 2700 Fort Campbell Boulevard, Hopkinsville, Kentucky 42240. The telephone number is (270) 885-1171. MARKET AND DIVIDEND INFORMATION - -------------------------------------------------------------------------------- Since February 9, 1998, the Common Stock has been quoted on the Nasdaq Stock Market under the symbol "HFBC." As of February 29, 2000, there were approximately 1,500 stockholders of record, excluding beneficial owners in nominee or street name. Following are the high and low stock prices of the Common Stock for the periods indicated. Price Range of Common Stock ------------------------------------------------------------ Year Ended December 31, 1998 Year Ended December 31, 1999 ----------------------------- ---------------------------- High Low High Low ---- --- ---- --- First Quarter $17.75 $16.00 $23.50 $17.00 Second Quarter 22.00 17.75 22.00 19.00 Third Quarter 19.625 15.25 22.875 19.00 Fourth Quarter 18.875 16.0625 21.9375 15.50 Dividends of $0.075 per share were declared in each of the third and fourth quarters of 1998 and in each of the four quarters of 1999. In December 1999, the Company declared a $4.00 per share special cash dividend in the form of a nontaxable return of capital. Dividends, when and if paid, are subject to determination and declaration by the Board of Directors in its discretion, which will take into account the Company's consolidated financial condition and results of operations, the Bank's regulatory capital requirements, tax considerations, economic conditions, regulatory restrictions, other factors, and there can be no assurance that dividends will be paid, or if paid, will continue to be paid in the future. The payment of future dividends by the Company will depend in large part upon the receipt of dividends from the Bank, which is subject to various tax and regulatory restrictions on the payment of dividends. TABLE OF CONTENTS - -------------------------------------------------------------------------------- HopFed Bancorp, Inc. ..................................... Inside Front Cover Market and Dividend Information........................... Inside Front Cover Selected Financial Information and Other Data............................. 1 Management's Discussion and Analysis of Financial Condition and Results of Operations.............................................. 4 Financial Statements...................................................... 16 Corporate Information...................................... Inside Back Cover SELECTED FINANCIAL INFORMATION AND OTHER DATA - -------------------------------------------------------------------------------- The following summary of selected financial information and other data does not purport to be complete and is qualified in its entirety by reference to the detailed information and Financial Statements and accompanying Notes appearing elsewhere in this Report.
FINANCIAL CONDITION AND OTHER DATA At December 31, ------------------------------------------------------ 1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- Total amount of: (Dollars in thousands) Assets ...................... $207,906 $220,032 $343,995 $204,398 $212,598 Loans receivable, net ....... 113,532 108,807 103,470 95,496 84,755 Cash and due from banks ..... 4,537 1,905 1,264 1,452 1,303 Time deposits and interest-bearing deposits in FHLB .................... 251 214 5,945 2,000 12,550 Federal funds sold .......... 4,100 9,685 151,095 500 7,948 Securities available for sale 71,423 68,139 26,699 5,125 4,053 Securities held to maturity: FHLB securities .......... -- 13,998 31,988 77,962 80,990 Mortgage-backed securities .. 9,958 13,356 19,578 17,984 17,563 Deposits .................... 160,905 154,816 320,633 183,827 194,775 FHLB advances ............... -- -- -- 1,317 -- Total equity ................ 44,346 61,134 19,936 16,824 16,002 -------- -------- -------- -------- -------- Number of: Real estate loans outstanding 2,143 2,150 2,198 2,151 2,074 Deposit accounts ............ 18,667 19,251 21,277 23,778 25,473 Offices open ................ 5 5 5 5 5 OPERATING DATA Year Ended December 31, ---------------------------------------------------- 1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- (In thousands) Interest income ................ $14,205 $ 15,051 $14,311 $13,220 $12,472 Interest expense ............... 7,078 8,004 9,350 9,757 10,009 ------- -------- ------- ------- ------- Net interest income before provision for loan losses .. 7,127 7,047 4,961 3,463 2,463 Provision for loan losses ...... 20 20 20 100 -- ------- -------- ------- ------- ------- Net interest income ............ 7,107 7,027 4,941 3,363 2,463 Non-interest income ............ 7,028 547 528 590 398 Non-interest expense ........... 8,894 2,982 2,408 3,674(1) 2,246 ------- -------- ------- ------- ------- Income before income taxes ..... 5,241 4,592 3,061 279 615 Provision for income taxes ..... 2,766 1,641 1,038 84 203 ------- -------- ------- ------- ------- Net income ..................... $ 2,475 $ 2,951 $ 2,023 $ 195(1) $ 412 ======= ======== ======= ======= =======
- ------------------ (1) Includes payment to the SAIF of a one-time deposit insurance special assessment of $1.2 million ($812,000 net of tax) pursuant to legislation enacted to recapitalize the Savings Association Insurance Fund ("SAIF"). SELECTED QUARTERLY INFORMATION (UNAUDITED) - --------------------------------------------------------------------------------
First Second Third Fourth Quarter Quarter Quarter Quarter ------- ------- ------- ------- (In thousands) YEAR ENDED DECEMBER 31, 1998: Interest income ....................... $ 4,317 $ 3,592 $ 3,578 $ 3,564 Net interest income after provision for losses on loans .................... 1,903 1,705 1,710 1,709 Noninterest income .................... 135 145 138 129 Noninterest expense ................... 578 622 594 1,188 Net income ............................ 968 794 829 360 YEAR ENDED DECEMBER 31, 1999: Interest income ....................... $ 3,500 $ 3,505 $ 3,495 $ 3,705 Net interest income after provision for losses on loans .................... 1,727 1,737 1,727 1,916 Noninterest income .................... 112 136 6,660 120 Noninterest expense ................... 880 2,662 1,437 3,915 Net income (loss) ..................... 592 (577) 4,547 (2,087)
2
KEY OPERATING RATIOS At or for the Year Ended December 31, ------------------------------------- 1999 1998 1997 ---- ---- ---- PERFORMANCE RATIOS Return on average assets (net income divided by average total assets) ........................................... 1.14% 1.29% 0.93% Return on average equity (net income divided by average total equity) ................................... 4.30% 5.76% 11.13% Interest rate spread (combined weighted average interest rate earned less combined weighted average interest rate cost) .............................................. 2.11% 2.07% 1.93% Ratio of average interest-earning assets to average interest-bearing liabilities ............................ 137.75% 130.08% 109.17% Ratio of non-interest expense to average total assets ..... 4.09% 1.30% 1.10% Ratio of net interest income after provision for loan losses to non-interest expense ................. 79.91% 235.65% 205.19% Efficiency ratio (noninterest expense divided by sum of net interest income plus noninterest income) ............ 62.92% 39.26% 44.03% ASSET QUALITY RATIOS Nonperforming assets to total assets at end of period ..... .03% 0.13% 0.05% Nonperforming loans to total loans at end of period ....... .05% 0.26% 0.16% Allowance for loan losses to total loans at end of period . .25% 0.24% 0.23% Allowance for loan losses to nonperforming loans at end of period ........................................... 479.31% 89.90% 145.40% Provision for loan losses to total loans receivable, net .. .02% 0.02% 0.02% Net charge-offs to average loans outstanding .............. N/A(1) N/A(1) N/A(1) CAPITAL RATIOS Total equity to total assets at end of period ............. 21.33% 27.78% 5.80% Average total equity to average assets .................... 26.46% 22.40% 8.33%
- ------------------- (1) Ratio is not applicable because there were no net charge-offs for this period. REGULATORY CAPITAL RATIOS December 31, 1999 ---------------------- (Dollars in thousands) Tangible capital .................... $44,971 21.60% Less: Tangible capital requirement 3,123 1.50 ------- ----- Excess ............................ $41,848 20.10% ======= ===== Core capital ........................ $44,971 21.60% Less: Core capital requirement ..... 8,327 4.00 ------- ----- Excess ............................ $36,644 17.60% ======= ===== Total risk-based capital ............ $45,249 58.60% Less: Risk-based capital requirement 6,177 8.00 ------- ----- Excess ............................ $39,072 50.60% ======= ===== 3 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- GENERAL This discussion relates to the financial condition and results of operations of the Company, which became the holding company for the Bank in February 1998. The principal business of the Bank consists of accepting deposits from the general public and investing these funds primarily in loans and in investment securities and mortgage-backed securities. The Bank's loan portfolio consists primarily of loans secured by residential real estate located in its market area. For the year ended December 31, 1999, the Company recorded net income of $2.5 million, a return on average assets of 1.14% and a return on average equity of 4.30%. For the year ended December 31, 1998, the Company recorded net income of $3.0 million, a return on average assets of 1.29% and a return on average equity of 5.76%. For the year ended December 31, 1997, the Company recorded net income of $2.0 million, a return on average assets of 0.93% and a return on average equity of 11.13%. The Company's net income is dependent primarily on its net interest income, which is the difference between interest income earned on its loan, investment securities and mortgage-backed securities portfolios and interest paid on interest-bearing liabilities. Net interest income is determined by (i) the difference between yields earned on interest-earning assets and rates paid on interest-bearing liabilities ("interest rate spread") and (ii) the relative amounts of interest-earning assets and interest-bearing liabilities. The Company's interest rate spread is affected by regulatory, economic and competitive factors that influence interest rates, loan demand and deposit flows. To a lesser extent, the Company's net income also is affected by the level of non-interest expenses such as compensation and employee benefits and FDIC insurance premiums. The operations of the Company and the entire thrift industry are significantly affected by prevailing economic conditions, competition and the monetary, fiscal and regulatory policies of governmental agencies. Lending activities are influenced by the demand for and supply of housing, competition among lenders, the level of interest rates and the availability of funds. Deposit flows and costs of funds are influenced by prevailing market rates of interest, primarily on competing investments, account maturities and the levels of personal income and savings in the Company's market area. BENEFIT PLAN RESTRUCTURING In December 1999, the Board of Directors approved a benefit plan restructuring on the basis of its belief that a reduction of the expenses associated with the Company's Employee Stock Ownership Plan ("ESOP") would improve the Company's profitability and, therefore, the Company's long-term prospects for independence. For the year ended December 31, 1999, the maintenance expenses for the ESOP were approximately $408,000, and the Company's one-time termination expense was approximately $2.5 million. Termination of the ESOP, effective December 31, 1999, and distribution to participants of its assets are contingent on receipt of an Internal Revenue Service determination that the ESOP will be tax-qualified upon its termination, as well as compliance with other applicable regulatory requirements. See Note 9 of Notes to Financial Statements. TAX FREE SPECIAL DIVIDEND In November 1999, the Company announced a special cash dividend of $4.00 per share, which totaled approximately $16.4 million. The special dividend represented a return to stockholders of a portion of the proceeds raised when the Company went public in February 1998. As a nontaxable return of capital, the special dividend reduced the tax cost basis of each outstanding share. The Board of Directors took this action because it believed that the Company's equity-to-assets ratio was excessive and would prove to be a deterrent to generating acceptable returns on equity over the long term. SALE OF FHLMC STOCK In August 1999, the Bank sold 100% of its Federal Home Loan Mortgage Corporation ("FHLMC") stock portfolio (123,072 shares) in open market transactions and realized an after-tax gain on such sales of approximately $4.3 million. The FHLMC stock had been recorded at its fair market value with the associated unrealized gains recorded in the Company's consolidated net worth. The sales were undertaken in recognition that the FHLMC stock had appreciated significantly over the last several years. Although the FHLMC had benefited from higher levels of mortgage loans fostered by lower interest rates in recent years, as a result of an uncertainty over the direction of interest rates and an apparent slowing of mortgage loan originations in general, the Company believed that the FHLMC stock would be subject to future adverse market pressures. 4 Additionally, the FHLMC was under increasing pressure to expand its role in promoting low income housing, which the Company believed may also depress the market value of the FHLMC stock. From December 31, 1998 to the date of sale, the Bank's FHLMC stock portfolio declined in value approximately 17%. Proceeds of these sales were invested in higher yielding investments. CURRENT BUSINESS STRATEGY Until 1996, the Company's primary focus was on asset growth by attracting deposits. The Company determined that deposits were the most suitable source of funding for the Bank because of their relative stability and the opportunity for the Bank to offer other income-producing products to its depositors. To attract deposits, the Company offered rates on accounts that were at or above then-prevailing rates in its market area. As a result of this practice, the Company's total assets increased each year until it reached $212.6 million at December 31, 1995. This strategy substantially increased the Company's interest expense and reduced profitability. The Company, however, was unable to deploy the significant amount of funds generated by this strategy solely through loan originations in its market area, as reflected in the loan-to-deposit ratio of 43.5% at December 31, 1995. As a result, the Company invested these funds in securities, primarily U.S. government and agency securities and mortgage-backed securities. See "--Asset/Liability Management." The yields on these investments were significantly less than the yields obtained by the Company on its loan portfolio. The combined lower weighted average yield on the Company's interest-earning assets, when reduced by the relatively high cost of the Company's deposits due to the Company's former deposit pricing strategy, tended to depress the Company's overall profitability. In 1996, the Company revised its business strategy to emphasize increased profitability over asset growth by attracting deposits on a less aggressive basis through a reduction in overall deposit rates. This reduction caused a deposit run-off during 1996 of approximately $10.9 million in higher-costing deposits. This run-off contributed to a reduction in the Company's total assets to $204.4 million at December 31, 1996 from $212.6 million at December 31, 1995. Deposits as a percentage of average assets decreased from 92.4% at December 31, 1995, to 87.8% at December 31, 1996. Deposits as a percentage of average assets were 147.0% at December 31, 1997, primarily as a result of subscriptions for Common Stock in the conversion. At December 31, 1998, deposits as a percentage of average assets were 67.7%. In 1999, the Company modified its policy to retain its deposit base through an increase in overall deposit rates. At December 31, 1999, deposits as a percentage of average assets were 74.0%. In addition, the Company has continued its emphasis on the origination of adjustable rate loans in its market area. In 1996, average loans increased $9.9 million, or 12.0%, from the 1995 average. In 1997, average loans increased $7.1 million, or 7.7%, from the 1996 average. And in 1998 and 1999, average loans increased $6.7 million and $5.6 million, respectively, or 6.8% and 5.3%, respectively, from the prior year's average. The Company's interest rate spread was 2.11%, 2.07% and 1.93% for each of the three years ended December 31, 1999. The Company's profitability in the years ended December 31, 1998 and 1999 also was primarily attributable to its current business strategy. The Company's net income, return on average assets and return on average equity were $3.0 million, 1.29% and 5.76%, respectively, for the year ended December 31, 1998. The Company's net income, return on average assets and return on average equity were $2.5 million, 1.14% and 4.30%, for the year ended December 31, 1999. See "Selected Financial Information and Other Data." The results to date which are attributable to the Company's current business strategy are not necessarily indicative of future results. ASSET/LIABILITY MANAGEMENT Key components of a successful asset/liability strategy are the monitoring and managing of interest rate sensitivity of both the interest-earning asset and interest-bearing liability portfolios. The Company has employed various strategies intended to minimize the adverse affect of interest rate risk on future operations by providing a better match between the interest rate sensitivity between its assets and liabilities. In particular, the Company's strategies are intended to stabilize net interest income for the long-term by protecting its interest rate spread against increases in interest rates. Such strategies include the origination of adjustable-rate mortgage loans secured by one-to-four family residential real estate, and, to a lesser extent, multi-family real estate loans and the origination of other loans with interest rates that are more sensitive to adjustment based upon market conditions than long-term, fixed-rate residential mortgage loans. For the year ended December 31, 1999, approximately $11.8 million of the one-to-four family residential loans originated by the Company (comprising 73.85% of such loans) had adjustable rates. 5 The Company used excess funds to invest in U.S. government and agency securities and mortgage-backed securities. Such investments have been made in order to manage interest rate risk, as well as to diversify the Company's assets, manage cash flow, obtain yields and maintain the minimum levels of qualified and liquid assets required by regulatory authorities. The U.S. government and agency securities consist of notes issued by the FHLB System and other government agencies. These securities generally are purchased for a term of five years or less, and are fixed-term, fixed rate securities, callable securities or securities which provide for interest rates to increase at specified intervals to pre-established rates, and thus improve the spread between the cost of funds and yield on investments. At December 31, 1999, approximately $16.0 million of the securities were due in one year or less, approximately $7.2 million were due in one to five years and approximately $14.2 million were due after ten years. However, at December 31, 1999, all of these securities had call provisions which authorize the issuing agency to prepay the securities at face value at certain pre-established dates. If, prior to their maturity dates, market interest rates decline below the rates paid on the securities, the issuing agency may elect to exercise its right to prepay the securities. At December 31, 1999, all of these securities are callable and/or due prior to December 31, 2000. It is currently anticipated that any funds available from a prepayment would be reinvested into those U.S. government and agency securities or mortgage-backed securities which the Company believes to be the most appropriate investments at that time, assuming lending opportunities are not then available. Notwithstanding their call feature, it is believed that investments in callable securities, which have improved the portfolio yield over alternative fixed yield, fixed maturity investments, have been beneficial. Mortgage-backed securities entitle the Company to receive a pro rata portion of the cash flow from an identified pool of mortgages. Although mortgage-backed securities generally offer lesser yields than the loans for which they are exchanged, mortgage-backed securities present lower credit risk by virtue of the guarantees that back them, are more liquid than individual mortgage loans, and may be used to collateralize borrowings or other obligations of the Company. Further, since they are primarily adjustable rate, mortgage-backed securities are helpful in limiting the Company's interest rate risk. For more information regarding investment securities, see Note 2 of Notes to Financial Statements. INTEREST RATE SENSITIVITY ANALYSIS The Company's profitability is affected by fluctuations in interest rates. A sudden and substantial increase in interest rates may adversely impact the Company's earnings to the extent that the interest rates on interest earning assets and interest bearing liabilities do not change at the same speed, to the same extent or on the same basis. As part of its effort to manage interest rate risk, the Bank monitors its net portfolio value ("NPV"), a methodology adopted by the OTS to assist the Bank in assessing interest rate risk. Generally, NPV is the discounted present value of the difference between incoming cash flows on interest-earning assets and other assets and outgoing cash flows on interest-bearing liabilities and other liabilities. The application of the methodology attempts to quantify interest rate risk as the change in the NPV which would result from a theoretical 200 basis point (1 basis point equals .01%) change in market rates. Both a 200 basis point increase in market interest rates and a 200 basis point decrease in market interest rates are considered. 6 The following table presents the Bank's NPV at December 31, 1999, as calculated by the OTS, based on information provided to the OTS by the Bank.
Net Portfolio Value NPV as % of PV of Assets ------------------------------------------------------- --------------------------------------- CHANGE $ Amount $ Change % Change IN RATES -------- -------- -------- NPV RATIO CHANGE (Dollars in thousands) +400 bp $-- $0 0% 0.00% 0bp +300 bp 38,320 -10,466 -21% 19.34% -373bp +200 bp 42,209 -6,577 -13% 20.79% -227bp +100 bp 45,763 -3,023 -6% 22.06% -101bp 0 bp 48,786 23.07% -100 bp 51,272 2,486 +5% 23.85% +78bp -200 bp 53,938 5,152 +11% 24.66% +160bp -300 bp 57,241 8,454 +17% 25.66% +260bp -400 bp -- 0 0% 0.00% 0bp
Interest Rate Risk Measures: 200 Basis Point (bp) Rate Shock Pre-Shock NPV Ratio: NPV as % of PV of Assets................. 23.07% Exposure Measure: Post-Shock NPV Ratio........................ 20.79% Sensitivity Measure: Change in NPV Ratio...................... 22bp The computation of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan prepayments and deposit decay rates, and should not be relied upon as indicative of actual results. The computations do not contemplate any actions the Bank could undertake in response to changes in interest rates. The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are "interest rate sensitive" and by monitoring an institution's interest rate sensitivity "gap." An asset or liability is said to be interest rate sensitive within a specific period if it will mature or reprice within that period. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within that time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities, and is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. At December 31, 1999, the Company had a positive one-year interest rate sensitivity gap of 22.59% of total interest-earning assets. Generally, during a period of rising interest rates, a negative gap position would be expected to adversely affect net interest income while a positive gap position would be expected to result in an increase in net interest income. Conversely during a period of falling interest rates, a negative gap would be expected to result in an increase in net interest income and a positive gap would be expected to adversely affect net interest income. 7 The following table sets forth the amounts of interest-earning assets and interest-bearing liabilities outstanding at December 31, 1999 which are expected to mature or reprice in each of the time periods shown.
Over One Over Five Over Ten One Year Through Through Through Over Fifteen or Less Five Years Ten Years Fifteen Years Years Total ------- ---------- ----- ------------- ----- ----- (Dollars in thousands) Interest-earning assets: Loans: One-to-four family......... $68,411 $3,014 $2,536 $13,844 $ -- $87,805 Multi-family residential... 2,165 -- -- -- -- 2,165 Construction............... 4,077 -- -- -- -- 4,077 Non-residential............ 12,291 -- -- -- -- 12,291 Secured by deposits........ 2,525 -- -- -- -- 2,525 Other consumer............. 270 4,400 -- -- -- 4,670 Time deposits and interest bearing deposits in FHLB...... 251 -- -- -- -- 251 Federal funds sold............ 4,100 -- -- -- -- 4,100 Securities.................... 17,540 6,985 13,597 -- -- 38,122 Mortgage-backed securities.... 26,485 13,707 747 53 2,267 43,259 -------- ------- ------- ------- ------- -------- Total....................... $138,115 $28,106 $16,880 $13,897 $2,267 $199,265 -------- ------- ------- ------- ------- -------- Interest-bearing liabilities: Deposits...................... $113,876 $44,085 -- -- -- $157,961 -------- ------- ------- ------- ------ -------- Interest sensitivity gap......... $25,445 $(17,185) $16,880 $13,897 $2,267 $41,304 ======= ========= ======= ======= ======= ======= Cumulative interest sensitivity gap........................... $25,445 $8,260 $25,140 $39,037 $41,304 $41,304 ======= ========= ======= ======= ======= ======= Ratio of interest-earning assets to interest-bearing liabilities.. 122.58% 62.06% N/A N/A N/A 137.75% ======= ========= ======= ======= ======= ======= Ratio of cumulative gap to total interest-earning assets. 12.77% 4.15% 12.62% 19.59% 20.73% 20.73% ======= ========= ======= ======= ======= =======
The preceding table was prepared based upon the assumption that loans will not be repaid before their respective contractual maturities, except for adjustable rate loans which are classified based upon their next repricing date. Further, it is assumed that fixed maturity deposits are not withdrawn prior to maturity and that other deposits are withdrawn or repriced within one year. Management of the Company does not believe that these assumptions will be materially different from the Company's actual experience. However, the actual interest rate sensitivity of the Company's assets and liabilities could vary significantly from the information set forth in the table due to market and other factors. The retention of adjustable-rate mortgage loans in the Company's portfolio helps reduce the Company's exposure to changes in interest rates. However, there are unquantifiable credit risks resulting from potential increased costs to borrowers as a result of repricing adjustable-rate mortgage loans. It is possible that during periods of rising interest rates, the risk of default on adjustable-rate mortgage loans may increase due to the upward adjustment of interest costs to the borrowers. 8 AVERAGE BALANCE, INTEREST AND AVERAGE YIELDS AND RATES The following table sets forth certain information relating to the Company's average interest-earning assets and interest-bearing liabilities and reflects the average yield on assets and average cost of liabilities for the periods and at the date indicated. Such yields and costs are derived by dividing income or expense by the average monthly balance of assets or liabilities, respectively, for the periods presented. Average balances are derived from month-end balances. Management does not believe that the use of month-end balances instead of daily balances has caused any material difference in the information presented. The table also presents information for the periods and at the date indicated with respect to the difference between the average yield earned on interest-earning assets and average rate paid on interest-bearing liabilities, or "interest rate spread," which savings institutions have traditionally used as an indicator of profitability. Another indicator of an institution's net interest income is its "net yield on interest-earning assets," which is its net interest income divided by the average balance of interest-earning assets. Net interest income is affected by the interest rate spread and by the relative amounts of interest-earning assets and interest-bearing liabilities. When interest-earning assets approximate or exceed interest-bearing liabilities, any positive interest rate spread will generate net interest income. At December 31, 1999 ------------------------------- Weighted Average Balance Yield/Cost ------- ---------- (Dollars in thousands) Interest-earning assets: Loans receivable, net................ $113,532 7.55% Securities available for sale........ 71,423 6.70% Securities held to maturity.......... 9,958 6.12% Time deposits and other interest- bearing cash deposits............. 4,351 5.27% -------- ------- Total interest-earning assets...... 199,264 7.12% Non-interest-earning assets............. 8,642 -------- Total assets......................... $207,906 ======== Interest-bearing liabilities: Deposits............................. $157,961 4.65% Non-interest-bearing liabilities........ 5,599 -------- Total liabilities.................. 163,560 Common stock............................ 39 Additional paid-in capital.............. 24,215 Retained earnings....................... 20,991 Unallocated ESOP shares................. -- Accumulated other comprehensive income............................... (899) -------- Total liabilities and equity....... $207,906 ======== Interest rate spread.................... 2.47% ------ Ratio of interest-earning assets interest-bearing liabilities......... 126.15% ====== (Continued on following page) 9
Year Ended December 31, ----------------------------------------------------------------------------------------------------- 1999 1998 1997 --------------------------------- ------------------------------ ------------------------------ Average Average Average Average Average Average Balance Interest Yield/Cost Balance Interest Yield/Cost Balance Interest Yield/Cost ------- -------- ---------- ------- -------- ---------- ------- -------- ---------- (Dollars in thousands) Interest-earning assets: Loans receivable, net... $111,469 $8,435 7.57% $105,837 $8,279 7.82% $99,126 $7,607 7.67% Securities available for sale.................. 73,863 4,204 5.69% 48,539 2,418 4.98% 11,405 412 3.61% Securities held to ..... maturity ........... 14,220 814 5.72% 36,777 2,360 6.42% 75,307 4,706 6.25% Time deposits and other interest-bearing cash deposits.............. 11,536 751 6.51% 32,480 1,994 6.13% 27,233 1,586 5.82% -------- ------ -------- ------ -------- ------ Total interest-earning assets.............. 211,088 14,204 6.73% 223,633 15,051 6.73% 213,071 14,311 6.72% ------ ------ ------ ------ ------ ---- Non-interest-earning assets 6,324 5,143 5,119 -------- -------- -------- Total assets............ $217,412 $228,776 $218,190 ======== ======== ======== Interest-bearing liabilities: Deposits............... $153,245 7,078 4.62% $171,922 8,004 4.65% $195,019 $9,341 4.79% Borrowings............. -- -- --% -- -- --% 161 9 5.59% -------- ------ ------ -------- ------ ------ -------- ------ ------ Total interest-bearing liabilities........ 153,245 7,078 4.62% 171,922 8,004 4.65% 195,180 9,350 4.79% ------ ------ ------ ------ ------ ---- Non-interest-bearing liabilities............ 6,641 5,629 4,829 -------- -------- -------- Total liabilities.... 159,886 177,551 200,009 Common stock.............. 40 32 -- Additional paid-in capital 40,442 31,492 -- Retained earnings......... 16,670 18,174 15,510 Unallocated ESOP shares... (2,318) (2,582) -- Accumulated other comprehensive income... 2,692 4,109 2,671 -------- -------- -------- Total liabilities and equity............. $217,412 $228,776 $218,190 ======== ======== ======== Net interest income....... $7,126 $7,047 $4,961 ======= ======= ======= Interest rate spread...... 2.11% 2.07% 1.93% ====== ====== ====== Net yield on interest-earning Assets................. 3.38% 3.15% 2.33% ====== ====== ====== Ratio of average interest-earning assets to average interest-bearing liabilities............ 137.75% 130.08% 109.17% ====== ====== ======
10 RATE VOLUME ANALYSIS The following table sets forth certain information regarding changes in interest income and interest expense of the Company for the periods indicated. For each category of interest-earning asset and interest-bearing liability, information is provided on changes attributable to: (i) changes in volume (changes in volume from year to year multiplied by the average rate for the prior year) and (ii) change in rate (changes in the average rate from year to year multiplied by the prior year's volume).
Year Ended December 31, -------------------------------------------------------------- 1999 vs. 1998 1998 vs. 1997 ----------------------------- ------------------------------- Increase Increase (Decrease) due to (Decrease) due to ----------------- ----------------- Total Total Increase Increase Rate Volume (Decrease) Rate Volume (Decrease) ---- ------ ---------- ---- ------ ---------- (Dollars in thousands) Interest-earning assets: Loans receivable .... $ (279) $ 440 $ 161 $ 157 $ 515 $ 672 Securities available for sale .......... 525 1,261 1,786 665 1,341 2,006 Securities held to maturity ............ (100) (1,448) (1,548) 62 (2,408) (2,346) Other interest- earning assets ..... 43 (1,286) (1,243) 102 306 408 ------- ------- ------- ------- ------- ------- Total interest- earning assets .... $ 189 $(1,033) $ (844) $ 986 $ (246) $ 740 ------- ------- ------- ------- ------- ------- Interest-bearing liabilities: Deposits ............ $ (61) $ (871) $ (932) $ (231) $(1,106) $(1,337) Borrowings .......... -- -- -- -- (9) (9) ------- ------- ------- ------- ------- ------- Total interest- bearing liabilities $ (61) $ (871) $ (932) $ (231) $(1,115) $(1,346) ------- ------- ------- ------- ------- ------- Increase (decrease) in net interest income .. $ 250 $ (162) $ 88 $ 1,217 $ 869 $ 2,086 ======= ======= ======= ======= ======= =======
COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 1999 AND DECEMBER 31, 1998 The Company's total assets decreased by $12.1 million, from $220.0 million at December 31, 1998 to $207.9 million at December 31, 1999. Federal funds sold decreased from $9.7 million at December 31, 1998 to $4.1 million at December 31, 1999. Securities held to maturity declined $17.4 million due to various issues maturing. A portion of such funds was reinvested in securities available for sale, which increased $3.3 million. The special dividend of $4.00 per share paid in December 1999 utilized $16.4 million. The Company's loan portfolio increased by $4.6 million during the year ended December 31, 1999. Net loans totaled $113.5 million and $108.8 million at December 31, 1999 and December 31, 1998, respectively. The increase in the loan activity during the year ended December 31, 1999 was due to the Company's efforts to increase its loan originations using funds currently held in investment securities. For the year ended December 31, 1999, the Company's average yield on loans was 7.57%, compared to 7.82% for the year ended December 31, 1998. At December 31, 1999, the Company's investments classified as "held to maturity" were carried at amortized cost of $9.9 million and had an estimated fair market value of $10.1 million, and its securities classified as "available for sale" had an estimated fair market value of $71.4 million. See Note 2 of Notes to Financial Statements. 11 The allowance for loan losses totaled $278,000 at December 31, 1999, an increase of $20,000 from the allowance of $258,000 at December 31, 1998. The ratio of the allowance for loan losses to loans was .24% at each of December 31, 1999 and 1998. Also at December 31, 1999, the Company's non-performing loans were $58,000, or .05% of total loans, compared to $287,000, or .26% of total loans, at December 31, 1998, and the Company's ratio of allowance for loan losses to non-performing loans at December 31, 1999 and December 31, 1998 was 479.3% and 89.9%, respectively. COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998 NET INCOME. The Company's net income for the year ended December 31, 1999 was $2.5 million compared to $3.0 million for the year ended December 31, 1998. NET INTEREST INCOME. Net interest income for the year ended December 31, 1999 was $7.1 million, compared to $7.0 million for the year ended December 31, 1998. The increase in net interest income for the year ended December 31, 1999 was primarily due to a slightly lower cost of funds. For the year ended December 31, 1998, the Company's average yield on total interest-earning assets was 6.73%, compared to 6.73% for the year ended December 31, 1998, and its average cost of interest-bearing liabilities was 4.62%, compared to 4.65% for the year ended December 31, 1998. As a result, the Company's interest rate spread for the year ended December 31, 1999 was 2.11%, compared to 2.07% for the year ended December 31, 1998, and its net yield on interest-earning assets was 3.38% for the year ended December 31, 1999, compared to 3.15% for the year ended December 31, 1998. INTEREST INCOME. Interest income decreased by $926,000 from $15.1 million to $14.2 million, or by 6.15%, during the year ended December, 1999 compared to 1998. This decrease was due to a decline in interest earning assets. The average balance of securities held to maturity declined $22.6 million, from $36.8 million at December 31, 1998, to $14.2 million at December 31, 1999. Average time deposits and other interest-bearing cash deposits decreased $21.0 million, from $32.5 million at December 31, 1998 to $11.5 million at December 31, 1999. Overall, average total interest-earning assets decreased $12.5 million from December 31, 1998 to December 31, 1999. The ratio of interest-earning assets to interest-bearing liabilities increased from 130.1% for the year ended December 31, 1998 to 137.8% for the year ended December 31, 1999. INTEREST EXPENSE. Interest expense decreased to $7.1 million for the year ended December 31, 1999, compared to $8.0 million for 1998. The decrease was primarily attributable to a decrease in deposits. The average cost of average interest bearing liabilities declined from 4.65% for the year ended December 31, 1998 to 4.62% for the year ended December 31, 1999. Over the same period, the average balance of deposits decreased from $171.9 million for the year ended December 31, 1998 to $153.2 million at December 31, 1999. PROVISION FOR LOAN LOSSES. The Company determined that an additional $20,000 provision for loan loss was required for the year ended December 31, 1999. For the year ended December 31, 1998, the Company determined that a $20,000 provision was warranted. NON-INTEREST EXPENSE. Total non-interest expense in the year ended December 31, 1999 was $8.9 million, compared to $3.0 million in 1998. This increase was primarily attributable to approximately $5.5 million of employee benefits. See Note 9 of Notes to Financial Statements. INCOME TAXES. The effective tax rate for the year ended December 31, 1999 was 52.6%, compared to 34.9% for 1998. This increase in the effective tax rate resulted from $2.9 million of employee benefits which were not deductible for income tax purposes. COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997 NET INCOME. The Company's net income for the year ended December 31, 1998 was $3.0 million, compared to $2.0 million for the year ended December 31, 1997. The increase in net income for the year resulted primarily from the Company's repositioning funds into higher yielding assets as well as a decline in the cost of funds. 12 NET INTEREST INCOME. Net interest income for the year ended December 31, 1998 was $7.0 million, compared to $5.0 million for the year ended December 31, 1997. The increase in net interest income for the year ended December 31, 1998 was primarily due to a lower cost of funds and a higher yield on interest-earning assets. For the year ended December 31, 1998, the average yield on total interest-earning assets was 6.73%, compared to 6.72% for the year ended December 31, 1997, and its average cost of interest-bearing liabilities was 4.65%, compared to 4.79% for the year ended December 31, 1997. As a result, the interest rate spread for the year ended December 31, 1998 was 2.07%, compared to 1.93% for the year ended December 31, 1997, and its net yield on interest-earning assets was 3.15% for the year ended December 31, 1998, compared to 2.33% for the year ended December 31, 1997. INTEREST INCOME. Interest income increased by $740,000 from $14.3 million to $15.1 million, or by 5.2%, during 1998 compared to 1997. This increase primarily resulted from an increase in the average yield on the loan portfolio, which was 7.82% for 1998 compared to 7.67% for 1997, as well as an increase in the average balance of loans to $105.8 million in 1998 compared to $99.1 million in 1997. INTEREST EXPENSE. Interest expense decreased $1.3 million, or 14.4%, to $8.0 million for the year ended December 31, 1998 from $9.4 million for the year ended December 31, 1997. The Company's strategy of less aggressively pricing its deposit products resulted in a decrease in its cost of funds as well as a reduction in the level of interest-bearing liabilities due to an outflow of higher cost deposits. At December 31, 1998, total deposits were $154.8 million, compared to $320.6 million at December 31, 1997, a decrease of 51.7%. PROVISION FOR LOAN LOSSES. The allowance for loan losses is established through a provision for loan losses based on management's evaluation of the risk inherent in its loan portfolio and the general economy. Such evaluation considers numerous factors, including general economic conditions, loan portfolio composition, prior loss experience, the estimated fair value of the underlying collateral and other factors that warrant recognition. The Company determined that a provision for loan loss of $20,000 was appropriate for the year ended December 31, 1998. The Company determined not to increase the level of the provision for loan losses, which was $20,000 in 1997. INCOME TAXES. The Company's effective tax rate for the year ended December 31, 1998 was 34.9%, compared to 33.9% for 1997. The increase in income tax expense of $602,000 in 1998 compared to 1997 was due to an increase in income. LIQUIDITY AND CAPITAL RESOURCES The Company has no business other than that of the Bank. Management believes dividends that may be paid from the Bank to the Company will provide sufficient funds for the Company's current and anticipated needs; however, no assurance can be given that the Company will not have a need for additional funds in the future. The Bank is subject to certain regulatory limitations with respect to the payment of dividends to the Company. Capital Resources. At December 31, 1999, the Bank exceeded all regulatory minimum capital requirements. For a detailed discussion of the OTS' regulatory capital requirements, and for a tabular presentation of the Bank's compliance with such requirements, see Note 13 of Notes to Financial Statements. Liquidity. Liquidity management is both a daily and long-term function of business management. If the Bank requires funds beyond its ability to generate them internally, the Bank believes that it could borrow funds from the FHLB. At December 31, 1999, the Bank had no outstanding advances from the FHLB. See Note 6 of Notes to Financial Statements. The Bank's primary sources of funds consist of deposits, repayment of loans and mortgage-backed securities, maturities of investments and interest-bearing deposits, and funds provided from operations. While scheduled repayments of loans and mortgage-backed securities and maturities of investment securities are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by the general level of interest rates, economic conditions and competition. The Bank uses its liquidity resources principally to fund existing and future loan commitments, to fund maturing certificates of deposit and demand deposit withdrawals, to invest in other interest-earning assets, to maintain liquidity, and to meet operating expenses. Management believes that loan repayments and other sources of funds will be adequate to meet the Bank's liquidity needs for the immediate future. In addition, the Bank is required to maintain minimum levels of liquid assets as defined by OTS regulations. This requirement, which may be varied at the direction of the OTS depending upon economic conditions and deposit flows, is based upon a percentage of deposits and short-term borrowings. The required minimum ratio is currently 4%. The Bank has historically maintained a level of liquid assets in excess of regulatory requirements. The Bank's liquidity ratios at December 31, 1999, 1998 and 1997 were 58.02%, 53.87% and 65.36%, respectively. 13 A portion of the Bank's liquidity consists of cash and cash equivalents. At December 31, 1999, cash and cash equivalents totaled $4.5 million. The level of these assets depends upon the Bank's operating, investing and financing activities during any given period. Although operating activities have historically generated a declining amount of cash flows, cash flows from operating activities increased during the year ended December, 1998 and decreased during the year ended December 1999. For the years ended December 31, 1997, 1998 and 1999, such cash flows were $2.4 million, $2.6 million and $1.4 million, respectively. Cash flows from investing activities were a net source of funds of $12.2 million and $127.7 million in 1999 and 1998 respectively. A principal source of cash flows in this area has been proceeds from the maturities of held-to-maturity securities, the volume of which reflects the prior emphasis on investments in such securities over loans. These proceeds were a source of cash flows of $50.3 million for 1997, $24.2 million for 1998 and $17.4 million for 1999. At the same time, the investment of cash in loans was $4.7 million in 1999, $5.4 million in 1998 and $8.0 million in 1997, while purchases of held-to-maturity securities were $5.9 million in 1997. There were no purchases of held-to-maturity securities in 1998 and 1999. Further, the Bank has re-positioned the investment of its excess funds to enhance their availability. Funds not immediately invested in loans are sold on the federal funds market, which permits the Bank to earn a favorable rate of interest while maintaining daily access to such funds. Although the Bank continues to acquire securities using funds from loan repayments and proceeds from maturities of other securities, the liquidity position avoids the need to consider the sale of securities prior to maturity to satisfy lending or other operational commitments. At December 31, 1999, in addition to its federal funds sold and other liquid assets, which were 58.02% of deposits and short-term borrowings, the Bank had available an unused $10.1 million line of credit with the FHLB of Cincinnati. Beginning in 1996, the Bank permitted the run-off of higher-costing time deposits by offering only market rates of interest on maturing deposits rather than above-market rates under its previous pricing strategy. Cash was required to fund net withdrawals of time deposits in amounts of $7.8 million in 1997 and $16.5 million in 1998. The Bank modified this strategy in 1999, and had a net increase in deposits of $6.6 million. Because of the Bank's ability to generate cash flows from its financing activities and the availability of its other liquid assets, the Bank does not anticipate any difficulty in funding future withdrawals of such time deposits as they come due. At December 31, 1999, the Bank had $1.2 million in outstanding commitments to originate loans. The Bank anticipates that it will have sufficient funds available to meet its current loan origination commitments. Certificates of deposit which are scheduled to mature in one year or less totaled $63.8 million at December 31, 1999. Based on historical experience, management believes that a significant portion of such deposits will remain with the Bank. Another source of liquidity is net proceeds from the conversion. Following the completion of the conversion, the Bank received 50% of the net proceeds from the conversion or approximately $19.7 million, which are being used for the Bank's business activities. IMPACT OF INFLATION AND CHANGING PRICES The financial statements and notes thereto presented herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time and due to inflation. The impact of inflation is reflected in the increased cost of the Bank's operations. Unlike most industrial companies, nearly all the assets and liabilities of the Company are monetary in nature. As a result, changes in interest rates have a greater impact on the Company's performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the price of goods and services. YEAR 2000 Prior to January 1, 2000, the Company was aware of concerns throughout the business community of reliance upon computer software that did not properly recognize the Year 2000 in date formats, often referred to as the "Year 2000 Problem." The Year 2000 Problem was the result of software being written using two digits rather than four digits to define the applicable year (i.e., "98" rather than "1998"). A failure by a business to properly identify and correct a Year 2000 Problem in its operations could have resulted in system failures or miscalculations. In turn, this could have resulted in disruptions of operations, including among other things a temporary inability to process transactions, or otherwise engage in routine business transactions on a day-to-day basis. 14 Operations of the Company depend on the successful operation on a daily basis of its computer systems and a third party service bureau's equipment and software. In its analysis of these systems, equipment and software, a plan of action was put in place by the Bank to minimize its risk exposure to the Year 2000 Problem. As part of the plan, an oversight committee was set up to monitor Year 2000 compliance. The Company's service provider successfully completed the renovation of its equipment as well as proxy tests involving the participation of member institutions transmitting within a test institution created for this purpose. The service provider contracted with a recovery site in Philadelphia to cover Year 2000 contingencies and conducted Business Recovery Tests to ensure proper transmission with member institutions. The service provider's systems and equipment were well prepared for the Year 2000 Problem. The Company also renovated computer equipment, assessed mission-critical systems, reviewed tests and made contingency plans. The Company experienced no disruptions to normal business operations due to the Year 2000 Problem. As of December 31, 1999, the Company had incurred approximately $47,000 in direct compliance costs associated with the Year 2000 Problem. The Company estimates that $47,000 will approximate total direct compliance costs through the Year 2000. The Company does not separately track internal costs incurred for Year 2000 compliance, such costs are principally related to payroll expenditures. Funding for such costs has been and will be derived from normal operating cash flow. FORWARD-LOOKING STATEMENTS Management's discussion and analysis includes certain forward-looking statements addressing, among other things, the Bank's prospects for earnings, asset growth and net interest margin. Forward-looking statements are accompanied by, and identified with, such terms as "anticipates," "believes," "expects," "intends," and similar phrases. Management's expectations for the Bank's future involve a number of assumptions and estimates. Factors that could cause actual results to differ from the expectations expressed herein include: substantial changes in interest rates, and changes in the general economy; changes in the Bank's strategies for credit-risk management, interest-rate risk management and investment activities. Accordingly, any forward-looking statements included herein do not purport to be predictions of future events or circumstances and may not be realized. 15 LETTERHEAD OF YORK, NEEL & CO.-HOPKINSVILLE, LLP 1113 BETHEL STREET HOPKINSVILLE, KY 42240 (270)886-0206/FAX (270)886-0875 INDEPENDENT AUDITOR'S REPORT To the Board of Directors and Stockholders of Hopfed Bancorp, Inc. We have audited the accompanying consolidated statements of financial condition of HopFed Bancorp, Inc. and subsidiary (the "Company") as of December 31, 1999 and 1998, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Hopfed Bancorp, Inc. and subsidiary as of December 31, 1999 and 1998, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 1999 in conformity with generally accepted accounting principles. /s/: York, Neel & Co.-Hopkinsville, LLP Hopkinsville, Kentucky February 4, 2000 HOPFED BANCORP, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION December 31, 1999 and 1998 ASSETS
1999 1998 ------------- ------------- Cash and due from banks $ 4,537,222 $ 1,904,620 Interest-earning deposits in Federal Home Loan Bank 250,750 214,166 Federal funds sold 4,100,000 9,685,000 Securities available for sale 71,423,331 68,139,383 Securities held to maturity, market value of $10,078,157 for 1999 and $27,633,452 for 1998, respectively 9,958,147 27,354,099 Loans receivable, net of allowance for loan losses of $278,144 for 1999 and $257,744 for 1998, respectively 113,532,380 108,806,634 Accrued interest receivable 1,094,810 1,157,252 Premises and equipment, net 2,471,523 2,546,349 Deferred tax assets 514,744 -- Other assets 23,252 224,711 ------------- ------------- Total assets $ 207,906,159 $ 220,032,214 ============= ============= LIABILITIES AND STOCKHOLDERS' EQUITY Deposits: Noninterest-bearing accounts $ 2,943,337 $ 2,730,676 Interest-bearing accounts: Demand/NOW accounts 9,017,284 8,624,089 Money market accounts 30,062,939 30,771,443 Passbook savings 9,802,140 10,194,223 Other time deposits 109,079,053 102,495,354 ------------- ------------- Total deposits 160,904,753 154,815,785 Advances from borrowers for taxes and insurance 155,861 165,799 Federal income taxes payable: Current 369,242 -- Deferred -- 3,268,965 Dividends payable 307,364 302,524 Accrued expenses and other liabilities 1,822,514 345,195 ------------- ------------- Total liabilities 163,559,734 158,898,268 ------------- ------------- Stockholders' Equity: Common stock par value $.01 per share; 7,500,000 shares authorized; 3,942,500 shares issued and outstanding 39,425 40,336 Additional paid in capital 24,214,409 39,546,434 Retained earnings-substantially restricted 20,991,195 18,983,884 Unallocated ESOP shares -- (2,932,666) Accumulated other comprehensive income (loss) (898,604) 5,495,958 ------------- ------------- Total stockholders' equity 44,346,425 61,133,946 ------------- ------------- Total liabilities and stockholders' equity $ 207,906,159 $ 220,032,214 ============= =============
The accompanying notes are an integral part of these consolidated financial statements. 2 HOPFED BANCORP, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME For the Years Ended December 31, 1999, 1998, and 1997
1999 1998 1997 ---- ---- ---- Interest income: Loans receivable $ 8,435,464 $ 8,279,744 $ 7,606,685 Securities available for sale 4,204,268 2,418,597 412,355 Securities held to maturity 814,048 2,359,611 4,705,678 Time deposits 751,108 1,993,546 1,586,451 ----------- ----------- ----------- Total interest income 14,204,888 15,051,498 14,311,169 ----------- ----------- ----------- Interest expense: Deposits 7,078,126 8,003,911 9,340,884 Other borrowed funds -- -- 9,336 ----------- ----------- ----------- Total interest expense 7,078,126 8,003,911 9,350,220 ----------- ----------- ----------- Net interest income 7,126,762 7,047,587 4,960,949 Provision for loan losses 20,400 20,300 20,000 ----------- ----------- ----------- Net interest income after provision for loan losses 7,106,362 7,027,287 4,940,949 ----------- ----------- ----------- Noninterest income: NOW account fees 196,309 168,153 150,640 Loan fees 177,111 228,949 207,706 Service charges 67,095 84,852 82,807 Realized gain from sale of securities available for sale 6,523,526 -- -- Other 64,289 65,300 86,566 ----------- ----------- ----------- Total noninterest income 7,028,330 547,254 527,719 ----------- ----------- ----------- Noninterest expenses: Salaries and benefits 7,625,889 1,959,406 1,479,118 Deposit insurance premium 90,767 151,701 120,084 Occupancy expense 197,249 188,093 211,986 Data processing 143,266 117,368 113,941 Other 836,548 565,844 482,716 ----------- ----------- ----------- Total noninterest expense 8,893,719 2,982,412 2,407,845 ----------- ----------- ----------- Income before income taxes 5,240,973 4,592,129 3,060,823 Income tax expense 2,765,704 1,640,707 1,038,254 ----------- ----------- ----------- Net income $ 2,475,269 $ 2,951,422 $ 2,022,569 =========== =========== =========== Earnings per share: Basic $ 0.65 $ 0.80 N/A Fully diluted 0.65 0.80 N/A The accompanying notes are an integral part of these consolidated financial statements.
3 HOPFED BANCORP, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY For the Years Ended December 31, 1999 and 1998
Additional Unallocated Accumulated Other Common Paid-in Retained Common Stock Comprehensive Total Stock Capital Earnings Held by ESOP Income (Loss) Equity --------- ----------- ------------ ------------- ----------------- ------------ Balance, January 1, 1998 $ - $ - $ 16,613,308 $ - $ 3,322,769 $ 19,936,077 Comprehensive income: Net income 2,951,422 Unrealized holding gains arising during the period on securities available- for-sale, net of taxes of $1,119,410 2,173,189 Total comprehensive income 5,124,611 Issuance of common stock 40,336 39,334,954 39,375,290 Purchase of common stock by ESOP (3,226,900) (3,226,900) Release and allocation of common stock held by ESOP 211,480 294,234 505,714 Cash dividends paid net of dividends on ESOP shares (580,846) (580,846) --------- ---------- ------------ ----------- ----------- ----------- Balance, December 31, 1998 40,336 39,546,434 18,983,884 (2,932,666) 5,495,958 61,133,946 Comprehensive income (loss): Net income 2,475,269 Other comprehensive income (loss) Unrealized holding losses arising during the period net of tax effect of ($1,076,170) (2,089,035) Less: reclassification adjustment for gains included in net income net of tax effect of ($2,217,999) (4,305,527) ----------- Net change in unrealized gains (losses) on securities available-for- sale (6,394,562) ----------- Total comprehensive loss (3,919,293) Issuance of common stock - MRP 646 1,290,094 1,290,740 Retirement of common stock (from ESOP) (1,557) (1,555,063) 1,556,620 - Release and allocation of common stock held by ESOP 993,643 1,376,046 2,369,689 Cash dividends paid net of dividends on ESOP shares (16,060,699) (467,958) (16,528,657) -------- ----------- ------------ ----------- ----------- ----------- Balance, December 31, 1999 $ 39,425 $24,214,409 $ 20,991,195 $ - $ (898,604) $44,346,425 ======== =========== ============ =========== =========== =========== The accompanying notes are an integral part of these consolidated financial statements. 4
HOPFED BANCORP, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 1999, 1998 and 1997
1999 1998 1997 ------------ ------------ ------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 2,475,269 $ 2,951,422 $ 2,022,569 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 20,400 20,300 20,000 Depreciation 121,291 110,518 130,337 Accretion of investment security discounts (424,431) (40,113) (48,539) Amortization of investment security premiums 37,287 -- -- Provision (benefit) for deferred income taxes (489,541) 182,541 (244,697) Stock dividend (134,100) (127,200) (118,500) (Gain) loss on sale of equipment 1,100 (6,527) (4,741) Earned ESOP shares 2,899,941 211,480 MRP shares 1,290,740 -- -- Gain on sale of FHLMC stock (6,523,526) -- -- (Increase) decrease in: Accrued interest receivable 62,442 26,556 106,600 Other assets 201,459 214,202 (142,190) Increase (decrease) in: Current income taxes payable 369,242 (360,231) 360,231 ESOP contribution payable (294,234) 294,234 -- Accrued expenses and other liabilities 1,477,337 (555,551) 343,814 ------------- ------------- ------------- Net cash provided by operating activities 1,090,676 2,921,631 2,424,884 ------------- ------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES: Net decrease in time deposits -- 2,000,000 -- Net (increase) decrease in interest-bearing deposits in FHLB (36,584) 3,730,455 (3,944,621) Net (increase) decrease in federal funds sold 5,585,000 141,410,000 (150,595,000) Proceeds from maturities of held-to-maturity securities 17,407,471 24,229,625 50,336,539 Purchases of held-to-maturity securities -- -- (5,909,005) Proceeds from maturities of available-for-sale securities 56,226,497 12,565,393 81,009 Purchases of available-for-sale securities (68,809,959) (50,590,246) (19,895,099) Proceeds from sale of FHLMC stock 6,644,034 -- -- Net increase in loans (4,746,146) (5,356,773) (8,036,005) Purchase of premises/equipment (47,565) (327,565) (258,961) Proceeds from sale of premises/equipment -- 10,700 132,766 ------------- ------------- ------------- Net cash provided by (used in) investing activities 12,222,748 127,671,589 (138,088,377) ------------- ------------- ------------- CASH FLOWS FROM FINANCING ACTIVITIES: Net increase (decrease) in demand deposits, savings and NOW deposits (494,731) (149,270,443) 144,631,967 Net increase (decrease) in time deposits 6,583,699 (16,546,373) (7,826,732) Increase (decrease) in advance payments by borrowers for taxes and insurance (9,938) (5,720) (12,601) Net increase (decrease) in other borrowed funds -- -- (1,317,000) Issuance of common stock -- 36,148,390 -- Dividends paid (17,515,618) (278,322) -- Payments on loan to ESOP 755,766 -- -- ------------- ------------- ------------- Net cash provided by (used in) financing activities (10,680,822) (129,952,468) 135,475,634 ------------- ------------- ------------- Increase (decrease) in cash and cash equivalents 2,632,602 640,752 (187,859) Cash and cash equivalents, beginning of period 1,904,620 1,263,868 1,451,727 ------------- ------------- ------------- Cash and cash equivalents, end of period $ 4,537,222 $ 1,904,620 $ 1,263,868 ============= ============= ============= SUPPLEMENTAL DISCLOSURES Interest paid $ 7,068,469 $ 8,503,476 $ 9,128,049 ============= ============= ============= Income taxes paid $ 2,735,164 $ 1,969,233 $ 670,074 ============= ============= ============= Non-cash transaction - ESOP loan redeemed with stock $ 2,471,134 $ -- $ -- ============= ============= ============= The accompanying notes are an integral part of these consolidated financial statements.
5 HOPFED BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accounting and reporting policies of Hopfed Bancorp, Inc. (the "Company") and subsidiary conform with generally accepted accounting principles and to general practice within the banking industry. The following is a description of the more significant policies which the Company follows in preparing and presenting its consolidated financial statements. A. BASIS OF PRESENTATION The accompanying consolidated financial statements include the amounts of the Company and its wholly-owned subsidiary, Hopkinsville Federal Savings Bank (the "Bank"). All significant intercompany transactions and balances are eliminated in consolidation. As more fully discussed in Note 1.b., the Company, a Delaware corporation, was organized by the Bank for the purpose of acquiring all the capital stock of the Bank pursuant to the conversion of the Bank from a federally chartered mutual savings bank to a federally chartered stock savings bank. The Company is subject to the financial reporting requirements of the Securities and Exchange Act of 1934, as amended. B. ORGANIZATION/FORM OF OWNERSHIP The Bank was originally founded as a mutual savings bank in 1879. Effective February 6, 1998, the Bank converted from a federally chartered mutual savings bank to a federally chartered stock savings bank, as a wholly-owned subsidiary of a holding company chartered under Delaware law for the purpose of acquiring control of the Bank following consummation of the Bank's conversion. The Company completed its initial public offering on February 6, 1998 and issued 4,033,625 shares of common stock resulting in proceeds of $39,375,290, net of expenses totaling $960,960. The Company loaned $3,226,900 to the ESOP which purchased 322,690 shares of the Company's stock in the initial public offering. The Bank established, in accordance with the requirements of the Office of Thrift Supervision (OTS), a liquidation account for $18,732,503, the amount of the Bank's net worth as of the date of the latest statement of financial condition, September 30, 1997, appearing in the IPO prospectus supplement. The liquidation account will be maintained for the benefit of eligible deposit account holders who maintain their deposit accounts in the Bank after conversion. Continued 6 HOPFED BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) B. ORGANIZATION/FORM OF OWNERSHIP, (CONTINUED) In the event of a complete liquidation (and only in such an event) and prior to any payment to stockholders, each eligible deposit account holder will be entitled to receive a liquidation distribution from the liquidation account in an amount proportionate to the depositor's current adjusted balance for deposit accounts held before any liquidation. Except for the repurchase of stock and payment of dividends by the Bank, the existence of the liquidation account will not restrict the use or application of such net worth. The Bank may not declare or pay a cash dividend on or repurchase any of its capital stock if the effect thereof would cause the Bank's net worth to be reduced below the capital requirements imposed by the OTS. C. CASH AND CASH EQUIVALENTS For the purpose of presentation in the consolidated statements of cash flows, cash and cash equivalents are defined as those amounts included in the consolidated statements of financial condition "cash and due from banks". D. SECURITIES HELD TO MATURITY Bonds, notes and debentures for which the Bank has the positive intent and ability to hold to maturity are reported at cost, adjusted for premiums and discounts that are recognized in interest income over the period to maturity using the level yield method. Declines in the fair value of individual held-to-maturity securities below their cost that are other than temporary result in write-downs of the individual securities to their fair value. The write-downs are included in earnings as realized losses. E. SECURITIES AVAILABLE FOR SALE Available-for-sale securities consist of bonds, notes, debentures, and certain equity securities not classified as trading securities nor as held-to-maturity securities. Continued 7 HOPFED BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) E. SECURITIES AVAILABLE FOR SALE, CONTINUED Unrealized holding gains and losses, net of tax, on available-for-sale securities are reported as a net amount in other comprehensive income. Gains and losses on the sale of available-for-sale securities are determined using the specific identification method. Declines in the fair value of individual available-for-sale securities below their cost that are other than temporary result in write-downs of the individual securities to their fair value. The write-downs are included in earnings as realized losses. Premiums and discounts are recognized in interest income over the period to maturity using the level yield method. F. LOANS RECEIVABLE Loans receivable are stated at unpaid principal balances, less the allowance for loan losses and discounts. Discounts on home improvement and consumer loans are recognized over the lives of the loans using the interest method. Loan origination fee income is recognized as received and direct loan origination costs are expensed as incurred. Statement of Financial Accounting Standard ("SFAS") No. 91 requires the recognition of loan origination fee income over the life of the loan and the recognition of certain direct loan origination costs over the life of the loan. However, deferral of such fees and costs would not have a material effect on the financial statements. Uncollectible interest on loans that are contractually past due is charged off, or an allowance is established based on management's periodic evaluation. The allowance is established by a charge to interest income equal to all interest previously accrued, and income is subsequently recognized only to the extent that cash payments are received while the loan is classified as nonaccrual. Loans may be returned to accrual status when all principal and interest amounts contractually due (including arrearages) are reasonably assured of repayment within an acceptable period of time, and there is a sustained period of repayment performance by the borrower in accordance with the contractual terms of interest and principal. Continued 8 HOPFED BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) F. LOANS RECEIVABLE (CONTINUED) The Bank provides an allowance for loan losses and includes in operating expenses a provision for loan losses determined by management. Management's periodic evaluation of the adequacy of the allowance is based on the Bank's past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, and current economic conditions. Management believes it has established the allowance in accordance with generally accepted accounting principles and has taken into account the views of its regulators and the current economic environment. G. FORECLOSED REAL ESTATE Real estate properties acquired through, or in lieu of, loan foreclosure are carried at the lower of cost or fair value less cost to sell. Costs of developing such real estate are capitalized, whereas costs relating to holding the property are expensed. Valuations are periodically performed by management, and any adjustments to value are made through an allowance for losses. H. INCOME TAXES Income taxes are accounted for through the use of the asset and liability method. Under the asset and liability method, deferred taxes are recognized for the tax consequences of temporary differences by applying enacted statutory rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. The effect on deferred taxes of a change in tax rates would be recognized in income in the period that includes the enactment date. I. PREMISES AND EQUIPMENT Land is carried at cost. Land improvements, buildings, and furniture and equipment are carried at cost, less accumulated depreciation and amortization. Buildings and land improvements are depreciated generally by the straight-line method, and furniture and equipment are depreciated under accelerated methods over the estimated useful lives of the assets. The estimated useful lives used to compute depreciation are as follows: Continued 9 HOPFED BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) I. PREMISES AND EQUIPMENT (CONTINUED) Land improvements 5-15 years Buildings 40 years Furniture and equipment 5-15 years J. FINANCIAL INSTRUMENTS In the ordinary course of business, the Bank has entered into off-balance-sheet financial instruments consisting of commitments to extend credit, etc. Such financial instruments are recorded in the financial statements when they are funded or related fees are incurred or received. K. FAIR VALUES OF FINANCIAL INSTRUMENTS The following methods and assumptions were used by the Bank in estimating fair values of financial instruments as disclosed herein: CASH AND SHORT TERM INSTRUMENTS. The carrying amounts of cash and short term instruments approximate their fair value. AVAILABLE-FOR-SALE AND HELD-TO-MATURITY SECURITIES. Fair values for securities are based on quoted market prices. LOANS RECEIVABLE. For variable rate loans that reprice annually and have no significant change in credit risk, fair values are based on carrying values. Fair values for fixed rate mortgage loans and fixed rate commercial loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. DEPOSIT LIABILITIES. The fair values disclosed for demand deposits are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts). The carrying amounts of variable rate, fixed-term money market accounts approximate their fair values at the reporting date. Fair values for fixed rate certificates of deposits (CD's) are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates of deposit to a schedule of aggregated expected annual maturities on time deposits. Continued 10 HOPFED BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) K. FAIR VALUES OF FINANCIAL INSTRUMENTS (CONTINUED) ADVANCES FROM BORROWERS FOR TAXES AND LICENSES. The carrying amounts of advances from borrowers approximate their fair value. OTHER BORROWED FUNDS. The carrying amounts of other borrowed funds approximate their fair values since such borrowings mature within 90 days. ACCRUED INTEREST. The carrying amounts of accrued interest approximate their fair values. OFF-BALANCE-SHEET INSTRUMENTS. Off-balance-sheet lending commitments approximate their fair values due to the short period of time before the commitment expires. L. ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. M. EARNINGS PER SHARE Earnings per share is computed by dividing net income by the weighted average number of shares of common stock and dilutive common stock equivalents outstanding, adjusted for the unallocated portion of shares held by the Employee Stock Ownership Plan (ESOP). For the year ended December 31, 1999, basic and fully diluted weighted average common stock outstanding was 3,800,971 shares, (adjusted for unallocated ESOP shares). 2. SECURITIES Securities, which consist of debt and equity investments, have been classified in the consolidated statements of financial condition according to management's intent. The carrying amount of securities and their approximate fair values follow: Continued 11 HOPFED BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 2. SECURITIES (CONTINUED)
Gross Gross Estimated Amortized Unrealized Unrealized Market Cost Gains Losses Value ---- ----- ------ ----- Available-For-Sale Securities December 31, 1999: Restricted: FHLB stock $ 1,986,700 $ -- $ -- $ 1,986,700 Intrieve stock 15,000 -- -- 15,000 ------------ ------------ ------------ ------------ 2,001,700 -- -- 2,001,700 ------------ ------------ ------------ ------------ Unrestricted: U.S. government and agency securities: FHLB investment securities 33,411,633 180 (1,103,991) 32,307,822 FFCB 4,000,000 -- (187,500) 3,812,500 Mortgage-backed securities: GNMA 13,634,537 141,473 -- 13,776,010 FNMA 9,943,909 29,931 (115,733) 9,858,107 FHLMC 9,793,075 40,071 (165,954) 9,667,192 ------------ ------------ ------------ ------------ 70,783,154 211,655 (1,573,178) 69,421,631 ------------ ------------ ------------ ------------ $ 72,784,854 $ 211,655 $ (1,573,178) $ 71,423,331 ============ ============ ============ ============ December 31, 1998: Restricted: FHLB stock $ 1,852,600 $ -- $ -- $ 1,852,600 Intrieve stock 15,000 -- -- 15,000 ------------ ------------ ------------ ------------ 1,867,600 -- -- 1,867,600 ------------ ------------ ------------ ------------ Unrestricted: FHLMC stock 120,508 7,871,480 -- 7,991,988 U.S. government and agency securities: FHLB investment securities 7,000,000 50,310 -- 7,050,310 FFCB 15,995,265 20,000 -- 16,015,265 Mortgage-backed securities: GNMA 16,800,955 205,697 -- 17,006,652 FNMA 8,575,909 57,131 -- 8,633,040 FHLMC 9,451,937 132,567 (9,976) 9,574,528 ------------ ------------ ------------ ------------ 57,944,574 8,337,185 (9,976) 66,271,783 ------------ ------------ ------------ ------------ $ 59,812,174 $ 8,337,185 $ (9,976) $ 68,139,383 ============ ============ ============ ============
The scheduled maturities of securities available-for-sale at December 31, 1999 were as follows: Amortized Fair Cost Value ---- ----- Due in one to five years $15,996,875 $15,538,300 Due in five to ten years 7,205,856 6,984,576 Due after ten years 14,208,902 13,597,446 ----------- ----------- 37,411,633 36,120,322 Mortgage-backed securities 33,371,521 33,301,309 ----------- ----------- $70,783,154 $69,421,631 =========== =========== Continued 12 HOPFED BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 2. SECURITIES (CONTINUED) FHLB stock is an equity interest in the Federal Home Loan Bank. Intrieve stock is an equity interest in Intrieve, Incorporated, the Bank's data processing service center. These stocks do not have readily determinable fair values because ownership is restricted and a market is lacking. FHLB stock and Intrieve stock are classified as restricted investment securities, carried at cost and evaluated for impairment.
Gross Gross Estimated Amortized Unrealized Unrealized Market Cost Gains Losses Value ---- ----- ------ ----- HELD-TO-MATURITY SECURITIES December 31, 1999: Mortgage-backed securities: GNMA $ 8,898,170 $ 137,006 $ (1,764) $ 9,033,412 FNMA 1,059,977 -- (15,232) 1,044,745 ------------ ------------ ------------ ------------ $ 9,958,147 $ 137,006 $ (16,996) $ 10,078,157 ============ ============ ============ ============ December 31, 1998: U.S. government and agency securities: FHLB investment securities $ 13,997,542 $ 5,098 $ (1,410) $ 14,001,230 ------------ ------------ ------------ ------------ Mortgage-backed securities: GNMA 11,900,966 242,338 (30) 12,143,274 FNMA 1,455,591 33,357 -- 1,488,948 ------------ ------------ ------------ ------------ 13,356,557 275,695 (30) 13,632,222 ------------ ------------ ------------ ------------ $ 27,354,099 $ 280,793 $ (1,440) $ 27,633,452 ============ ============ ============ ============
Continued 13 HOPFED BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 3. LOANS RECEIVABLE The components of loans in the consolidated statements of financial condition as of December 31, 1999 and 1998 were as follows: 1999 1998 ---- ---- Real estate loans: One-to-four family $ 88,248,441 $ 88,954,630 Multi-family 2,165,271 1,538,864 Construction 5,706,152 4,625,527 Non-residential 12,398,156 8,260,156 ------------- ------------- Total mortgage loans 108,518,020 103,379,177 ------------- ------------- Consumer loans: Loans secured by deposits 2,525,120 2,279,709 Other consumer loans 4,670,123 4,586,487 ------------- ------------- Total consumer loans 7,195,243 6,866,196 ------------- ------------- 115,713,263 110,245,373 Less: Undisbursed portion of mortgage loans (1,902,739) (1,180,995) ------------- ------------- Total loans 113,810,524 109,064,378 Less allowance for loan losses (278,144) (257,744) ------------- ------------- $ 113,532,380 $ 108,806,634 ============= ============= An analysis of the change in the allowance for loan losses for the years ended December 31, 1999 and 1998 follows: 1999 1998 ---- ---- Balance at beginning of year $257,744 $237,444 Loans charged off - - Recoveries - - -------- -------- Net loans charged off - - Provision for loan losses 20,400 20,300 -------- -------- Balance at end of year $278,144 $257,744 ======== ======== Continued 14 HOPFED BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 4. PREMISES AND EQUIPMENT Components of properties and equipment included in the consolidated statements of financial condition as of December 31, 1999 and 1998 consisted of the following: 1999 1998 ---- ---- Land $ 543,013 $ 543,013 Land improvements 74,861 74,861 Buildings 2,069,632 2,061,675 Furniture and equipment 507,435 583,189 ----------- ----------- 3,194,941 3,262,738 Less accumulated depreciation (723,418) (716,389) ----------- ----------- $ 2,471,523 $ 2,546,349 =========== =========== Depreciation expense was $121,291, $110,518 and $130,337 for the years ended December 31, 1999, 1998 and 1997, respectively. 5. DEPOSITS At December 31, 1999, the scheduled maturities of other time deposits were as follows: 2000 $ 63,788,091 2001 35,293,973 2002 4,388,233 2003 2,994,782 2004 2,613,974 ------------- $ 109,079,053 ============= The amount of other time deposits with a minimum denomination of $100,000 was $10,379,000, and $7,161,825 at December 31, 1999 and 1998, respectively. Deposits in excess of $100,000 are not federally insured. Continued 15 HOPFED BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 5. DEPOSITS (CONTINUED) Interest expense on deposits for the years ended December 31, 1999, 1998, and 1997 is summarized as follows: 1999 1998 1997 ------------ ------------- ------------ Demand / NOW accounts $ 215,736 $ 222,674 $ 212,759 Money market accounts 1,320,265 1,346,675 1,619,467 Passbook savings 274,064 673,383 794,300 Other time deposits 5,268,061 5,761,179 6,714,358 ----------- ----------- ------------ $ 7,078,126 $ 8,003,911 $ 9,340,884 =========== =========== ============ The Bank maintains clearing arrangements for its demand, NOW and money market accounts with the Federal Home Loan Bank of Cincinnati. The Bank is required to maintain certain cash reserves in its account to cover average daily clearings. At December 31, 1999, average daily clearings were approximately $565,081. 6. OTHER BORROWED FUNDS During 1996, the Bank entered into a Cash Management Advance (CMA) program with the Federal Home Loan Bank. This program is a source of overnight liquidity to address day-to-day cash needs. The program has a term of up to 90 days and bears interest at a variable rate equal to the FHLB cost of funds (approximately 5.6% at December 31, 1999). At December 31, 1999, the Bank could borrow up to $10,170,300 under the CMA program and the amount would be collateralized by $9,204,088 of FHLB investment securities. The balance owed at December 31, 1999 and 1998 was zero. Subsequent to year end, the bank increased its limit to $20,000,000 and increased the collateral pledged. On February 4, 2000, the bank had borrowed $15,550,000 at a rate of 5.82%. 7. FINANCIAL INSTRUMENTS The Bank is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and commercial letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the statements of financial condition. The contract or notional amounts of those instruments reflect the extent of the Bank's involvement in particular classes of financial instruments. Continued 16 HOPFED BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 7. FINANCIAL INSTRUMENTS (CONTINUED) The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and commercial letters of credit is represented by the contractual notional amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. Unless noted otherwise, the Bank does not require collateral or other security to support financial instruments with credit risk. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank's experience has been that most loan commitments are drawn upon by customers. The Bank has offered standby letters of credit on a limited basis. As of December 31, 1999, the Bank has not been requested to advance funds on any of the standby letters of credit. The estimated fair values of financial instruments were as follows at December 31, 1999: Carrying Fair Amount Value ------ ----- Financial assets: Cash and due from banks $ 4,537,222 $ 4,537,222 Interest-earning deposits in FHLB 250,750 250,750 Federal funds sold 4,100,000 4,100,000 Securities available for sale 71,423,331 71,423,331 Securities held to maturity 9,958,147 10,078,157 Loans receivable 113,532,380 113,825,355 Accrued interest receivable 1,094,810 1,094,810 Financial liabilities: Deposit liabilities 160,904,753 160,802,661 Advances from borrowers for taxes and insurance 155,861 155,861 Off-balance-sheet liabilities: Commitments to extend credit 1,208,900 Commercial letters of credit 382,119 Continued 17 HOPFED BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 7. FINANCIAL INSTRUMENTS (CONTINUED) The estimated fair values of financial instruments were as follows at December 31, 1998: Carrying Fair Amount Value ------ ----- Financial assets: Cash and due from banks $ 1,904,620 $ 1,904,620 Interest-earning deposits in FHLB 214,166 214,166 Federal funds sold 9,685,000 9,685,000 Securities available for sale 68,139,383 68,139,383 Securities held to maturity 27,354,099 27,633,452 Loans receivable 108,806,634 108,966,659 Accrued interest receivable 1,157,252 1,157,252 Financial liabilities: Deposit liabilities 154,815,785 154,987,013 Advances from borrowers for taxes and insurance 165,799 165,799 Off-balance-sheet liabilities: Commitments to extend credit 464,789 Commercial letters of credit 679,744 8. SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK Most of the Bank's business activity is with customers located within the western part of the Commonwealth of Kentucky. The majority of the loans are collateralized by a one-to-four family residence. The Bank requires collateral for all loans. The distribution of commitments to extend credit approximates the distribution of loans outstanding. The contractual amounts of credit-related financial instruments such as commitments to extend credit and commercial letters of credit represent the amounts of potential accounting loss should the contract be fully drawn upon, the customer default, and the value of any existing collateral become worthless. Cash on deposit with financial institutions and federal funds sold exceeded the insurance coverage as of December 31, 1999 and 1998. The carrying amount and bank balance of such items as of December 31, 1999 and 1998 was as follows: Continued 18 HOPFED BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 8. SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK (CONTINUED) 1999 1998 ---- ---- Carrying amount $5,794,889 $10,655,165 ========== =========== Bank balance 4,811,533 9,783,412 Amount covered by insurance (446,260) (422,374) ---------- ----------- Amount not collateralized $4,365,273 $ 9,361,038 ========== =========== 9. EMPLOYEE BENEFITS PENSION PLAN The Bank maintains a contributory, defined benefit pension plan covering substantially all of its employees who satisfy certain age and service requirements. The benefits are based on years of service and the employee's average earnings which are computed using the five consecutive years prior to retirement that yield the highest average. Hopkinsville Federal's funding policy is to contribute annually, actuarially determined amounts to finance the plan benefits. The following table sets forth the plan's funded status and amounts recognized in the consolidated statements of financial condition at December 31: 1999 1998 ---- ---- Change in benefit obligation Benefit obligation at beginning of year $ 2,489,410 $ 2,176,248 Service cost 80,542 74,924 Interest cost 171,417 151,986 Actuarial loss (252,951) 86,252 Benefits paid (105,259) -- ----------- ----------- Benefit obligation at end of year 2,383,159 2,489,410 ----------- ----------- Change in plan assets Fair value of plan assets at beginning of year 1,666,076 1,421,158 Actual return on plan assets 211,876 93,803 Employer contributions 168,357 151,115 Benefits paid (105,259) -- ----------- ----------- Fair value of plan assets at end of year 1,941,050 1,666,076 ----------- ----------- Funded status (442,109) (823,334) Unrecognized net asset (41,742) (49,002) Unrecognized prior service cost 84,048 102,281 Unrecognized net loss 267,857 643,762 ----------- ----------- Accrued pension cost $ (131,946) $ (126,293) =========== =========== Continued 19 HOPFED BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 9. EMPLOYEE BENEFITS (CONTINUED) PENSION PLAN (CONTINUED) Weighted average assumptions used to develop the net periodic pension cost were: 1999 1998 1997 ---- ---- ---- Discount rate 7.75% 7.00% 7.00% Expected long-term rate of return on assets 7.00% 7.25% 8.00% Rate of increase in compensation levels 4.50% 4.50% 4.50% The components of net periodic pension cost for the years ended December 31, were as follows:
1999 1998 1997 ---- ---- ---- Service cost $ 80,542 $ 74,924 $ 67,026 Interest cost on projected benefit obligation 171,417 151,986 142,868 Expected return on plan assets (125,078) (112,256) (120,164) Amortization of transitional asset (7,260) (7,260) (7,995) Amortization of prior service cost 18,233 18,233 18,233 Amortization of net loss 36,156 33,069 9,388 --------- --------- --------- Net periodic pension cost $ 174,010 $ 158,696 $ 109,356 ========= ========= =========
EMPLOYEE STOCK OWNERSHIP PLAN The Company had a noncontributory employee stock ownership plan (ESOP) for those employees who met the eligibility requirements of the plan. Eligible employees were those who had attained the age of 21 and completed one year of service. This plan was terminated effective December 31, 1999, subject to approval by the Internal Revenue Service. The ESOP trust borrowed $3,226,900 in 1998 through a loan from the Company and used the proceeds to purchase 322,690 shares of the common stock at a price of $10.00 per share. Shares purchased were held in a suspense account for allocation among the participants as the loan was paid. Contributions to the ESOP and shares released from the loan collateral were in amounts proportional to repayment of the ESOP loan. Continued 20 HOPFED BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 9. EMPLOYEE BENEFITS (CONTINUED) EMPLOYEE STOCK OWNERSHIP PLAN (CONTINUED) The ESOP was funded by contributions made by the Company or the Bank in cash or shares of Common Stock with no cost to participants. Contributions to the ESOP and shares released from the suspense account were allocated among participants on the basis of their annual wages subject to federal income tax withholding, plus any amounts withheld under a plan qualified under Sections 125 or 401(k) of the Code and sponsored by the Company or the Bank. Participants had to be employed at least 500 hours in a calendar year in order to receive an allocation. A participant became vested in his or her right to ESOP benefits upon his or her completion of three years of service. Dividends paid on allocated shares were expected to be paid to participants or used to repay the ESOP loan, and dividends on unallocated shares were expected to be used to repay the ESOP loan. With the exception of a special dividend of $4.00 per share paid on December 17, 1999, all dividends paid on ESOP shares in 1999 and 1998 were applied to the ESOP loan. In order to terminate the plan and to repay the ESOP loan, the ESOP surrendered 155,662 shares valued at $2,471,134 on December 31, 1999. This released all remaining shares from encumbrance for allocation to participants. At December 31, 1999 and 1998, shares allocated, and shares remaining in suspense were as follows: 1999 1998 ---- ---- Number of Shares Released and allocated 167,028 29,423 Suspense - 293,267 Fair Value Released and allocated $2,651,570 $ 505,714 Suspense - 5,040,520 The expenses recorded by the Company during 1999 and 1998 were as follows: 1999 1998 ---- ---- Contributions $ 364,726 $ 270,032 Dividends applied to ESOP debt 96,807 41,597 Excess of fair value of shares released and allocated over ESOP's cost 1,899,330 194,085 Special dividend paid 12/17/99 on unallocated and uncommitted shares 1,000,611 - ----------- ------------ Total ESOP compensation costs $ 3,361,474 $ 505,714 =========== ============ The Company's ESOP compensation costs exclude interest which is eliminated in consolidation. Continued 21 HOPFED BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 9. EMPLOYEE BENEFITS (CONTINUED) MANAGEMENT RECOGNITION PLAN On February 24, 1999, the Board of Directors of the Company adopted the HopFed Bancorp, Inc. Management Recognition Plan (the "MRP") which was subsequently approved at the 1999 Annual Meeting of Stockholders. Under the MRP, up to 161,345 shares of Common Stock may be awarded to selected directors and employees. On the effective date the Board of Directors awarded 161,342 shares of Common Stock which were subject to automatic plan share awards as provided in the MRP document. Under applicable accounting standards, the Company recognizes compensation expense of $20.00 per share which was the fair market value of the Common Stock on the effective date, with such amount being amortized over the expected vesting period for the awards. The MRP provides for the following vesting schedule: 33 1/3% at date of awards; 33 1/3% on January 1, 2000 and 33 1/3% on January 1, 2001 (subject to immediate vesting upon certain events, including death or normal retirement of recipient). The total compensation expense of the MRP will be $3,226,840 of which $2,678,284 is recognized in 1999. STOCK OPTION PLAN On February 24, 1999, the Board of Directors of the Company adopted the HopFed Bancorp, Inc. 1999 Stock Option Plan (the "Option Plan") which was subsequently approved at the 1999 Annual Meeting of Stockholders. Under the Option Plan, the option committee has discretionary authority to grant stock options and stock appreciation rights to such employees, directors and advisory directors as the committee shall designate. The Option Plan reserves 403,362 shares of Common Stock for issuance upon the exercise of options or stock appreciation rights. The Company will receive the exercise price for shares of Common Stock issued to Option Plan participants upon the exercise of their option, and will receive no monetary consideration upon the exercise of stock appreciation rights. The Board of Directors has granted options to purchase 403,360 shares of Common Stock under the Option Plan at an exercise price of $20.75 per share, which was the fair market value on the date of the grant. As a result of the special dividend of $4.00 per share paid in December, 1999, and in accordance with plan provisions, the number of options and the exercise price have been adjusted to 480,475 and $17.42 respectively. The options granted to participants became vested and exercisable as follows: 50% on date of grant and 50% on January 1, 2000 (subject to immediate vesting upon certain events, including death or normal retirement of participant). Continued 22 HOPFED BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 9. EMPLOYEE BENEFITS (CONTINUED) STOCK OPTION PLAN (CONTINUED) The Company has chosen to account for stock-based compensation using the intrinsic value method prescribed in APB No. 25. Since each option was granted at a price equal to the fair market value of one share of the Company's stock on the date of the grant, no compensation cost has been recognized. The following table compares reported net income and earnings per share to net income and earnings per share on a pro forma basis assuming that the Company accounted for stock-based compensation under SFAS No. 123. The effects of applying SFAS No. 123 in this pro forma disclosure are not indicative of future amounts. 1999 1998 1997 ---- ---- ---- Net Income As reported $2,475,269 N/A N/A Pro forma 211,088 Earnings per share As reported Basic $0.65 Diluted 0.65 Pro forma Basic 0.06 Diluted 0.06 STOCK OPTION ACTIVITY The following table sets forth stock option activity and the weighted average fair value of options granted. Year Ended December 31, 1999 Shares Exercise Price ------ -------------- Outstanding, beginning of year - Granted 403,360 $20.75 Adjustment due to special dividend 77,115 (3.33) Exercised - - Forfeited - - Outstanding, end of year 480,475 $17.42 ======= ====== Options exercisable as of December 31, 1999 240,238 Weighted average fair value of options granted $8.51 Continued 23 HOPFED BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 9. EMPLOYEE BENEFITS (CONTINUED) STOCK OPTION PLAN (CONTINUED) The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model using the following weighted average assumptions: risk free interest rate of 6.70%, volatility of 37.06%, expected dividend yield of 1.5% and expected life of six years. 10. INCOME TAXES The provision for income taxes for the years ended December 31, 1999, 1998 and 1997 consisted of the following: 1999 1998 1997 ---- ---- ---- Current: Federal $3,246,851 $1,421,164 $1,282,951 State 9,970 37,002 - ---------- ---------- ---------- 3,256,821 1,458,166 1,282,951 Deferred (491,117) 182,541 (244,697) ---------- ---------- ---------- $2,765,704 $1,640,707 $1,038,254 ========== ========== ========== Total income tax expense for the years ended December 31, 1999, 1998 and 1997 differed from the amounts computed by applying the U.S. federal income tax rate of 34 percent to income before income taxes as follows: 1999 1998 1997 ---- ---- ---- Expected federal income tax expense at statutory tax rate $1,781,931 $1,561,324 $1,040,680 State income taxes (3,390) (12,581) - Dividends received (8,838) (14,077) (11,716) Fair market value difference of allocated ESOP shares 985,980 71,903 - Other 51 (2,864) 9,290 ---------- ---------- ---------- Total federal income tax expense $2,755,734 $1,603,705 $1,038,254 ========== ========== ========== Effective rate 52.6% 34.9% 33.9% ========== ========== ========== Continued 24 HOPFED BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 10. INCOME TAXES (CONTINUED) The components of deferred taxes as of December 31, 1999 and 1998 are summarized as follows: 1999 1998 --------------- ---------- Deferred tax liabilities: FHLB stock dividends $ (402,961) $ (357,283) Post 1987 bad debt reserves (199,194) (248,993) Unrealized appreciation on securities available for sale - (2,831,251) ------------ ------------ (602,155) (3,437,527) ------------ ------------ Deferred tax assets: Bad debt reserves 93,691 86,755 Pension cost 44,862 42,940 Accrued interest expense 26,213 23,006 Accrued professional fees 17,451 15,861 Unrealized depreciation on securities available for sale 462,917 - Provision for MRP 471,765 - ------------ ------------ 1,116,899 168,562 ------------ ------------ Net deferred tax asset (liability) $ 514,744 $ (3,268,965) ============ ============ Thrift institutions, in determining taxable income, were previously allowed special bad debt deductions based on specified experience formulae or on a percentage of taxable income before such deductions. In August 1996, the President signed the Small Business Protection Act of 1996 that, among other things, repealed the tax bad debt reserve method for thrifts effective for taxable years beginning after December 31, 1995. As a result, thrifts must recapture into taxable income the amount of their post-1987 tax bad debt reserves over a six-year period beginning after 1995. This recapture could be deferred for up to two years if the thrift satisfied a residential loan portfolio test, and the Bank qualified for that deferral. For each of the years ended December 31, 1999 and 1998, the Bank recaptured $146,467 of the $878,800 total recapture of tax bad debt reserves into taxable income. A similar amount will be recaptured in each of the years 2000 through 2003. The recapture does not have any effect on the Bank's financial statements because the related tax expense has already been accrued. Thrifts such as the Bank may now only use the same tax bad debt reserve method that is allowed for banks. Accordingly, a thrift with assets of $500 million or less may only add to its tax bad debt reserves based upon its moving six-year average experience of actual loan losses (i.e., the experience method). A thrift with assets greater than $500 million can no longer use the reserve method and may only deduct loan losses as they actually arise (i.e., the specific charge-off method). The Bank expects to continue to use the reserve method. Continued 25 HOPFED BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 10. INCOME TAXES (CONTINUED) The portion of a thrift's tax bad debt reserve that is not recaptured (generally pre-1988 bad debt reserves) under the 1996 law is only subject to recapture at a later date under certain circumstances. These include stock repurchase redemptions by the thrift or if the thrift converts to a type of institution (such as a credit union) that is not considered a bank for tax purposes. However, no further recapture would be required if the thrift converted to a commercial bank charter or was acquired by a bank. The Bank does not anticipate engaging in any transactions at this time that would require the recapture of its remaining tax bad debt reserves. Therefore, retained earnings at December 31, 1999 and 1998 includes approximately $4,027,400 which represents such bad debt deductions for which no deferred income taxes have been provided. 11. RELATED PARTIES The Bank has entered into transactions with its directors and their affiliates (related parties). The aggregate amount of loans to such related parties at December 31, 1999 and 1998, was $283,602 and $302,259, respectively. During 1999, new loans to such related parties amounted to $12,155 and repayments amounted to $30,812. During 1998, new loans to such related parties amounted to $69,914 and repayments amounted to $31,447. 12. COMMITMENTS AND CONTINGENCIES In the ordinary course of business, the Bank has various outstanding commitments and contingent liabilities that are not reflected in the accompanying financial statements. The Bank had open loan commitments at December 31, 1999 and 1998 of $1,208,900 and $464,789 respectively. Of these amounts, $72,150 and $267,252 as of December 31, 1999 and 1998, respectively, were for fixed rate loans. The interest rates for the fixed rate loan commitments ranged from 7.875% to 9.00% and 7.375% to 8.50% for December 31, 1999 and 1998, respectively. In addition, the Bank is a defendant in legal proceedings arising in connection with its business. It is the best judgment of management that neither the financial position nor results of operations of the bank will be materially affected by the final outcome of these legal proceedings. Continued 26 HOPFED BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 13. REGULATORY MATTERS The Financial Institutions Reform Recovery and Enforcement Act of 1989 ("FIRREA"), which instituted major reforms in the operation and supervision of the savings and loan industry, contains provisions for capital standards. These standards require savings institutions to have a minimum regulatory tangible capital (as defined in the regulation) equal to 1.50% of adjusted total assets and a minimum 4.00% core capital (as defined) of adjusted total assets. Additionally, savings institutions are required to meet a total risk-based capital requirement of 8.00%. The Bank is also subject to the provisions of the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"). FDICIA includes significant changes to the legal and regulatory environment for insured depository institutions, including reductions in insurance coverage for certain kinds of deposits, increased supervision by the Federal regulatory agencies, increased reporting requirements for insured institutions, and new regulations concerning reporting on internal controls, accounting and operations. FDICIA's prompt corrective action regulations define specific capital categories based on an institution's capital ratios. The capital categories, in declining order, are "well capitalized", "adequately capitalized", "undercapitalized", "significantly undercapitalized", and "critically undercapitalized." Institutions categorized as "undercapitalized" or worse are subject to certain restrictions, including the requirement to file a capital plan with OTS, and increased supervisory monitoring, among other things. Other restrictions may be imposed on the institution either by the OTS or by the FDIC, including requirements to raise additional capital, sell assets, or sell the entire institution. The following chart delineates the categories as defined in the FDICIA legislation: Tier I Risk- Total Risk- Core Capital Based Capital Based Capital ------------ ------------- ------------- "Well capitalized" 5.0% 6.0% 10.0% "Adequately capitalized" 4.0% 4.0% 8.0% "Undercapitalized" Less than 4.0% Less than 4.0% Less than 8.0% "Significantly undercapitalized" Less than 3.0% Less than 3.0% Less than 6.0% Continued 27 HOPFED BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 13. REGULATORY MATTERS (CONTINUED) At December 31, 1999, the Bank's core, tier I risk-based, and total risk-based capital ratios were 21.60%, 58.24%, and 58.60%, respectively. The following is a calculation of the Bank's regulatory capital (in thousands) at December 31, 1999:
Tier I Total Risk- Risk- GAAP Based Tangible Core Based Capital Capital Capital Capital Capital ------- ------- ------- ------- ------- GAAP capital, as reported $44,072 $44,072 $44,072 $44,072 $44,072 ======= Unrealized losses on certain available-for- sale securities - 899 899 899 General valuation allowance - - - 278 ------------------------------------------------- Regulatory capital $44,072 44,971 44,971 45,249 ======= Minimum capital requirement % 1.50% 4.00% 8.00% Minimum capital requirement $ 3,123 8,327 6,177 ------- ------- ------- Regulatory capital excess $41,848 $36,644 $39,072 ======= ======= =======
At December 31, 1998, the Bank's core, tier I risk-based, and total risk-based capital ratios were 20.36%, 49.76%, and 50.11%, respectively. The following is a calculation of the Bank's regulatory capital (in thousands) at December 31, 1998:
Tier I Total Risk- Risk- GAAP Based Tangible Core Based Capital 1 Capital Capital Capital Capital --------- ------- ------- ------- ------- GAAP capital, as reported $41,369 $41,369 $41,369 $41,369 $41,369 ======= Unrealized gains on certain available-for- sale securities - (5,483) (5,483) (5,483) General valuation allowance - - - 257 ------- ------- ------- ------- Regulatory capital $41,369 $35,886 $35,886 $36,143 ======= Minimum capital requirement % 1.50% 4.00% 8.00% Minimum capital requirement $ 2,965 7,907 5,769 ------- ------- ------- Regulatory capital excess $32,921 $27,979 $30,374 ======= ======= =======
Continued 28 HOPFED BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998, AND 1997 13. REGULATORY MATTERS (CONTINUED) The OTS risk-based capital regulation also includes an interest rate risk ("IRR") component that requires savings institutions with greater than normal IRR, when determining compliance with the risk-based capital requirements, to maintain additional total capital. The OTS has, however, indefinitely deferred enforcement of its IRR requirements. Under the regulation, a savings institution's IRR is measured in terms of the sensitivity of its "net portfolio value" to changes in interest rates. A savings institution is considered to have a "normal" level of IRR exposure if the decline in its net portfolio value after an immediate 200 basis point increase or decrease in market interest rates is less than 2% of the current estimated economic value of its assets. If the OTS determines in the future to enforce the regulation's IRR requirements, a savings institution with a greater than normal IRR would be required to deduct from total capital, for purposes of calculating its risk-based capital requirement, an amount equal to one half the difference between the institution's measured IRR and 2%, multiplied by the economic value of the institution's total assets. Management does not believe that this regulation, when enforced, will have a material impact on the Bank. 14. HOPFED BANCORP, INC. The following condensed statements of financial condition as of December 31, 1999 and 1998 and condensed statements of income and cash flows for the year ended December 31, 1999 and the period February 6, 1998 through December 31, 1998 of the parent company only should be read in conjunction with the consolidated financial statements and the notes thereto. Continued 29 HOPFED BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 14. HOPFED BANCORP, INC. (CONTINUED) CONDENSED STATEMENT OF FINANCIAL CONDITION DECEMBER 31, 1999 AND 1998
1999 1998 ---- ---- ASSETS Cash and due from banks $ 429,509 $ 112,094 Federal funds sold 200,000 485,000 Securities available for sale - 16,015,265 Accrued interest receivable - 220,503 Other assets - 14,770 Investment in subsidiary 19,708,291 19,707,645 Note receivable-ESOP - 3,226,900 ------------ ------------- Total assets $ 20,337,800 $ 39,782,177 ============ ============= LIABILITIES AND EQUITY Liabilities: Federal income taxes payable: Current $ 48,408 $ - Deferred - 6,800 Dividends payable 307,364 302,524 ------------ ------------- Total liabilities 355,772 309,324 ------------ ------------- Equity: Common stock 39,425 40,336 Additional paid in capital 19,942,603 39,382,349 Retained earnings - 36,968 Accumulated other comprehensive income - 13,200 ------------ ------------- Total equity 19,982,028 39,472,853 ------------ ------------- Total liabilities and equity $ 20,337,800 $ 39,782,177 ============ ============= CONDENSED STATEMENT OF INCOME FOR THE YEAR ENDED DECEMBER 31,1999 AND FOR THE PERIOD FEBRUARY 6, 1998 THROUGH DECEMBER 31, 1998 Interest income Loans receivable $ 230,203 $ 246,482 Securities available for sale 620,306 502,884 Time deposits 192,819 320,040 ------------ ------------- Total interest income 1,043,328 1,069,406 ------------ ------------- Noninterest expenses Salaries and benefits 179,122 41,597 Other 158,792 45,765 ------------ ------------- Total noninterest expenses 337,914 87,362 ------------ ------------- Income before income taxes 705,414 982,044 Income tax expense 274,408 364,230 ------------ ------------- Net income $ 431,006 $ 617,814 ============ ==============
Continued 30 HOPFED BANCORP, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999, 1998 AND 1997 14. HOPFED BANCORP, INC. (CONTINUED) CONDENSED STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 1999 AND FOR THE PERIOD FEBRUARY 6, 1998 THROUGH DECEMBER 31, 1998
1999 1998 ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 431,006 $ 617,814 Adjustments to reconcile net income to net cash provided by operating activities Accretion of investment security discounts (403,320) (11,048) Earned ESOP shares 82,315 17,395 (Increase) decrease in: Accrued interest receivable 220,503 (220,503) Other assets 14,770 (14,770) Increase (decrease) in: Current income taxes payable 48,408 - ------------ ------------ Net cash provided by operating activities 393,682 388,888 ------------ ------------ CASH FLOWS FOR INVESTING ACTIVITIES: Investment in subsidiary - (19,707,645) Proceeds from sale of available-for-sale securities 32,898,585 - Purchase of available-for-sale securities (16,500,000) (15,984,217) Net (increase) decrease in federal funds sold 285,000 (485,000) Repayment of note receivable-ESOP 755,766 - ------------ ------------ Net cash provided (used) by investing activities 17,439,351 (36,176,862) ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Issuance of common stock - 36,178,390 Dividends paid (17,515,618) (278,322) ------------ ------------ Net cash provided (used) by financing activities (17,515,618) 35,900,068 ------------ ------------ Net increase in cash 317,415 112,094 Cash at beginning of year 112,094 - ------------ ------------ Cash at end of year $ 429,509 $ 112,094 ============ ============ SUPPLEMENTAL DISCLOSURE: Income taxes paid $ 221,228 $ 369,002 ============ ============ Non-cash transaction-ESOP loan redeemed with stock $ 2,471,134 - ============ ============
31 CORPORATE INFORMATION - -------------------------------------------------------------------------------- DIRECTORS AND EXECUTIVE OFFICERS WD Kelley Clifton H. Cochran Chairman of the Board Retired Retired Bruce Thomas Walton G. Ezell President and Chief Executive Officer of the Company and the Bank FARMER HARRY J. DEMPSEY, MD Peggy R. Noel Anesthesiologist Vice President, Chief Financial Officer and Treasurer of the Company and Executive Vice President, Chief Financial Officer and Chief Operations Officer of the Bank Boyd M. Clark Gilbert E. Lee Vice President and Secretary of the Company and Senior Vice President - Loan CO-OWNER, RELIABLE Administration of the Bank FINANCE INC. - -------------------------------------------------------------------------------- MAIN OFFICE 2700 Fort Campbell Boulevard Hopkinsville, KY 42240 (270/885-1171) BRANCH OFFICES Downtown Branch Office Murray Branch Office 605 South Virginia Street 7th and Main Streets Hopkinsville, KY 42240 (270/885-1171) Murray, KY 42071 (270/753-7921) 1 Cadiz Branch Office Elkton Branch Office 352 Main Street West Main Street Cadiz, KY 42211 (270/522-6638) Elkton, KY 42220 (270/265-5628) - -------------------------------------------------------------------------------- GENERAL INFORMATION
INDEPENDENT ACCOUNTANTS ANNUAL MEETING ANNUAL REPORT ON FORM 10-K York, Neel & Co.-- The 2000 Annual Meeting of Stockholders A COPY OF THE COMPANY'S 1999 ANNUAL Hopkinsville, LLP will be held on May 10, 2000 at 3:00 REPORT ON FORM 10-K WILL BE FURNISHED 1113 Bethel Street p.m. at Hopkinsville Federal Savings WITHOUT CHARGE TO STOCKHOLDERS AS OF THE Hopkinsville, KY 42240 Bank, 2700 Fort Campbell Boulevard, RECORD DATE FOR THE 2000 ANNUAL MEETING Hopkinsville, KY UPON WRITTEN REQUEST TO THE SECRETARY, HOPFED BANCORP, INC., 2700 FORT GENERAL COUNSEL TRANSFER AGENT CAMPBELL BOULEVARD, HOPKINSVILLE, KY Deatherage, Myers, Self & Lackey Registrar and Transfer Company 42240 701 South Main Street 10 Commerce Drive Hopkinsville, KY 42241 Cranford, NJ 07016 Special Counsel Kutak Rock 1101 Connecticut Avenue, N.W. Washington, D.C. 20036
2 EX-21 3 SUBSIDIARIES OF HOPFED BANCORP, INC. EXHIBIT 21 SUBSIDIARIES OF THE REGISTRANT Jurisdiction of Percentage Owned Incorporation ---------------- --------------- Hopkinsville Federal Savings Bank 100% United States EX-27 4 FDS -- HOPFED BANCORP, INC.
9 1,000 U.S. DOLLARS 12-MOS DEC-31-1999 JAN-01-1999 DEC-31-1999 1 4,537 251 4,100 0 71,423 9,958 10,078 113,532 278 207,906 106,905 0 2,655 0 0 0 39 44,307 207,906 8,436 5,018 751 14,205 7,078 0 7,127 20 6,524 8,893 5,241 2,475 0 0 2,475 .65 .65 3.38 0 58 0 0 278 0 0 278 278 0 0
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